Keep some powder dry ("liquidity") for 2016 private & public equity opportunities.

1.  Up to 2007 many public companies' share prices were higher due to use of leverage (debt) of companies and the "artificially-rich" middle class (using home equity loans) playing the market as most investments were only going up.

2.  These retail investors after seeing much of their windfall and principal erode in 2008 and 2009 went to the "safety" of low yields where earnings were 1/100% or 1/10% on every dollar held against the backdrop of the 2% inflation rate.  No way, with those returns, were they going to recoup their equity losses.

3.  The U.S. government creating market liquidity and velocity embraced a fiscal policy to print money (trillions of dollars) and inject it into our economy.  These funds made a Wall Street detour.  Institutions having taken a heavy hit in their investments and needing to recoup returned to the market to get their share.

4.  Despite the global financial malaise (and likely due to abundant shale and a glut of cheap oil) more affluent families and companies are "reporting" better results because all those dollars flooding the market were injected into the equities eventually creating "performance" at or exceeding 2007 levels.  A "rebound".... using a deflated 2015 dollars for comparison.  We dodged a bullet as the balance of industrialized nations did the same thing... later.  Now most nations ~ i.e., taxpayers, have taken on additional debt.  Add an influx of retail investors (late to the party) trying to restore their 2008 and 2009 losses.

5.  While the low interest rate environment wasn't so great for folks on fixed income and savers; it has been a boon to working families, corporations and for the housing market.  Who doesn't want a low-interest rate new car or 65" flat screen television?  (Yet, credit card rates haven't declined, but balances have returned after folks went cold-turkey from their buying sprees.) But these prices and rates are artificial contrivances with no correlation with risks that influence their levels.  As rates rise, home price growth will slow and so may the economy 

6.  Wall Street has little to do with main street.  Modern portfolio theory has almost nothing to do with individual company performance; hence, the distinction between a market of stocks and the stock market with the former requiring due diligence and deep analytics.  Do institutional investors, who represent the majority of stock trades, really believe the daily pundits of what's causing the market's rise or fall?  What does quarterly performance have to do with legitimate mid- and long-term performance/market risk?  If 2007 share prices were a result of corporate debt, what is driving the high prices now? 

7.  Are GOP members fiscal conservatives, when the left uses higher taxes and the right uses debt to pay for what special interests want?  Likely both presidential candidates after the primaries will feed from the Wall Street trough. Somehow they'll convince the working- and middle-class struggling to support their families and pay for their kids' higher education or vocational training that their parties' fiscal policies will be job creators if just the right skills were held.

8.  If Warren Buffet's selections have the Midas touch, why don't most follow his selections with the same net returns?  Because he uses a major insurance company that shields most taxes and selects boring companies whose steady growth compounds.  Who needs homeruns if you can double the value with steady growth every six years.  His own estate plan and two Economics Nobel Laureates have indicated index funds are the best hedge for buy-and-hold investors and low loads (costs).  This is why Vanguard is the behemoth it is.

9. So, what does this have to do with keeping powder dry?  Most investment bankers know there has been a steady decline in many sectors for midmarket company transactions since 2H15.  Yet, too much cash chasing too few deals has kept values inflated.  Then there's the herd of institutional advisors endeavoring to attract the mildly or more wealthy to follow a common path creating a self-fulfilling prophecy of marginal performance as the majority can't all be on the buy or sell side.  Seldom does conventional wisdom create massive wealth.  Ask any entrepreneur with concentrated risk.  It is they and the contrarian value and activist investors digging deeper who can.  If the music stops creating illiquidity and a downward pressure on equities 2016 is likely to be a buyers' market. 

10. If the market correction is more abrupt than in 2008, many opportunities will be abound in the broader market.  Yet, many $50 - $500 million companies (public and private) are already fairly priced or below market because they're thinly traded or private.  (LINK) This due diligence and operator skills is not simply a matter of financial engineering.  Often values are influenced by board and management decisions with an almost slavish focus on revenues, profits and taxes, instead of the risks that can often most influence equity price multiples

Am I being a prognosticator, a pragmatist or a pundit?  What does your crystal ball say?

Posted on January 11, 2016 .