A different week, the same old red ink.
I can’t imagine I will be the only person happy to see October in the rear-view mirror. I mean, talk about everyone having a crisis of confidence at the same time. Holy smoke, gee whiz, or whatever ancient exclamation you want to throw at it. I only ask you keep it G or PG, and leave the swearing to the professionals.
After all, this has been a professional-grade freak out, but a freak out it is and nothing more.
Since you are reading this, I am going to assume you consume more investment and business news than the average person. As such, you are probably aware Amazon’s stock is taking a real beating today, after delivering a solid earnings report yesterday afternoon. Solid, eh Norris? Did you not see the lousy guidance the company gave for the upcoming 4th Quarter? Further, 3Q revenue didn’t beat analysts’ estimates; in fact, it trailed it by 0.91%.
Sure, I saw it all of that and more. However, I am not one to get all down in the mouth about a company that thinks upcoming 4Q revenue will be ‘only’ 15% higher than last year’s 4Q (midpoint to actual). Seriously. The company predicts 15% sales growth and folks head for the exits? There must be something more here than meets the eye, and I propose there is.
Do you want to know why all these tech stocks have been baring the brunt of October’s discontent? The truth is stranger than fiction: large institutional portfolio managers are locking in their 2018 outperformance relative to the benchmark. There is no reason for them NOT to do so.
You see, the folks that manage, let’s call it, XYZ mutual fund get a bonus based on how the fund performs against some index. In essence, their livelihood if predicated by RELATIVE performance and NOT ABSOLUTE. Make money or lose money for their clients? It doesn’t matter as much for their paychecks as beating the bogey. I have been there and done that.
Now, why tech and why now? Well, if you have been overweight technology sector stocks, and especially names like Amazon (technically consumer discretionary) and Alphabet, you are comfortably ahead of the comparison entering the 4Q. So, why wouldn’t you take your overweight positions in these names back to the index weight AND lock in a market return during 4Q. By doing so, voila, you lock in your bonus.
You read that right.
So, what happens when, say, Fidelity (and I can’t prove they are currently doing this and won’t be able to do so for a couple of months yet) decides to take its weight in Amazon from (arbitrary) 4.0% to 2.5%? I will tell you what: they put a lot more shares out for sale than there are buyers. So, they put them out in blocks, and try to do so under the radar…they work it.
However, how many firms have the capability of absorbing a 1.5% reduction in a position from a massive company like Fidelity? Not many, unless they are active buyers themselves. So, what happens when the folks at Fidelity, American Century, American Funds, Federated, et al. have the same idea(s) at the same time? Where is the backstop then?
I will give you three guesses and if one of them isn’t “there ain’t one” you lose. So, cue the retail investor and the sudden, ‘surprising’ shift in market psyche. That is how you get a huge gap down in companies like Alphabet and Amazon after solid, but not necessarily exceptional, earnings reports. There isn’t any buying, not yet anyway.
Now, let me ask you this question: why do the markets tend to rally in November and December, and they do, after disappointing Octobers? This is kind of how it goes. Come a little closer, and I will whisper in your ear: “BECAUSE ALL THAT CASH PEOPLE RAISED IN OCTOBER FROM LOCKING IN INCENTIVE PAY AND THE SUBSEQUENT FREAKING OUT BY RETAIL HAS TO GO SOMEWHERE!”
Clearly, this might look like collusion, but it really isn’t. It is simply how the game is played at certain lofty levels. But why not be ahead of the markets and sell in September and buy back at the end of October. Ah! Why not market time these seasonal shifts? Great question, and let answer it with a little analogy.
I AM a Southerner after all.
Have you ever been stuck in a traffic jam? Dumb question, huh? How about standing still in the middle of the interstate when you are running late for a meeting? That’s the worst, isn’t it? Now, there is probably a pretty good chance most of us look at our phones to find the quickest alternate route. Where is it? When is the next exit? You feeling it?
Now, sometimes Google maps (or whichever one you use) can find a quicker way, but, more often than not, it can’t…particularly if you are on the interstate and the alternate route is an amalgam of, well, not interstate. To be sure, you CAN deviate from the proscribed directions. You CAN choose a path of your own choosing. You CAN decide to take a different way all you want. However, the chances are you will get there after you would have had you just taken your lumps on the highway. That is what market timing is like.
Throw in capital gains tax considerations, fair dealing standards, priority of transaction standards, and whole operational kitchen sink of trading a vast number of individual accounts and the answer is: it doesn’t pay and is incredibly difficult to do it correctly. The mutual fund gang(s)…it doesn’t matter. It is one account (a mutual fund) against one benchmark comparison, and someone they have never met (and will never meet) has to pay the tax bill and worry about all the compliance and operational issues. That is meat of the matter: the year-end incentives these folks are locking in around this time of year are based, again, on RELATIVE to a benchmark for a specific (and relatively short) period of time. It is NOT based on absolute, risk-adjusted, and after-tax returns…you know, the ones that actually matter to individual investors.
So, market timing? Going back to the analogy, at least you were moving or something. Yeah, I tell my wife that all the time when we get home later than expected.
In the end, as my letters this month to investors have stated, we are not terribly considered with this month’s volatility. We don’t like it, and really don’t like how it makes our clients feel. However, it is just part of the game. The markets don’t just permanently fall apart when the economic, financial, and profit data are as good as they are.
…on those things, I have no crisis of confidence and I will be looking forward to the end of this month. Perhaps folks will feel better things in November, they normally do.
Take care
John Norris