April 2014 Investor Letter

Model Portfolio Update

Executive Summary

I presented at the Irish Association of Pension Funds (IAPF) annual investment conference in the Convention Centre last week and will post a copy of my presentation to the website shortly. While my presentation was targeted towards defined benefit pension scheme trustees, you will be familiar with many of the investment themes I discussed.

We are now one quarter way through 2014. The economic climate continues to improve but this has already been discounted by the equity market. Stock valuations are expensive and we are long overdue a correction. Our defensive position has been rewarded so far in 2014 as gold and bonds have outperformed stocks year to date. I expect this trend to continue as the year progresses. If you would like to learn more about the services we provide, please contact Brian Delaney at 086 821 5911.

Equity Market Update

It's déja vu all over again. For the third time in a little over a decade, we have returned to bubble-like valuations and sentiment readings in the stock market. Investors are once again being lured into paying huge premiums for low quality new issues. Investment banks are lining up to take advantage of soaring prices and speculative demand. In the September 2013 to March 2014 period, three quarters of all IPO's announced in the US were of money-losing businesses. Only in 2000 did we see a greater number of unprofitable businesses taken public. Already this year, we have seen 42 initial public offerings (IPO's), matching the prior peak in 2007 just before the last bubble burst. Private company executives are once again enthusiastically selling their shares to an unsuspecting public and heading for the exits. Again, only in 2000 did the number of IPO's eclipse the current tally.


In another perfect example of the current speculative mood, Facebook recently agreed to pay $19 billion for the free messaging service Whatsapp, a company with 60 employees and no revenues. I am sure Mark Zuckerberg has big plans for Whatsapp, including selling a lot of advertising to its 190 million users and perhaps charging an annual fee to use the service. It might work, but would you pay for 'Whatsapp' if you could download 'Telegram' for free? Telegram is one of a number of similar free messaging services that is growing rapidly and offering essentially the same service as Whatsapp with a few extra bells and whistles. Zuckerberg will have his work cut out for him to make his latest purchase work out.

Central banks have successfully spiked the punch bowl, suppressing interest rates and volatility, and driving investors once again to speculate, taking uncomfortable levels of risk. On almost any metric, the US equity market is historically quite expensive. There is a growing gap between the financial markets and the real economy. The trend is still up for stocks and as the music continues to play, market participants continue to party like it's 1999. However, at some point in the not too distant future, the music will stop and the trend will turn. Investors will experience another harsh lesson as their unrealised profits turn to losses. Capital preservation will become the name of the game once again and dreams of untold riches from stock market speculation will fade into distant memory. Not yet, but soon.

Some of the smartest money managers I know are currently holding 50% of their portfolio in cash. 50%! Despite the exuberance that has returned to stock market investing in the past 12 months, there is actually plenty about which to be concerned. One example is the recent survey of U.S. investment newsletters by Investors Intelligence, which identified the lowest proportion of bears on the stock market today since the ill-fated year of 1987.


In another example of bull market exuberance, leveraged loan issuance by banks is now surging. Banks are lending to low grade corporates with abandon and re-packaging those loans in high yielding ETF's, which investors are snapping up. The next chart shows the three-month sum of leveraged loan issuance versus the price of the S&P 500. The last few times the S&P suffered corrections, it coincided with a run-up in leveraged loan issuance. It also happened at the peak in 2007, but to a much small degree than today. The past three peaks saw total issuance of between $150 - $200 billion during the prior three months. Today, this figure is $487 billion, double the previous peak! 


Needless to say, we remain cautious in our investment outlook and our model portfolio continues to reflect this view with an allocation of 20% stocks, 50% bonds, 20% gold and 10% cash. There is a time to swing for the fences and a time for capital preservation. Today, we believe it is time for the latter.

Bond Market Update

Bond Yields.JPG

Eurozone government bonds have continued to perform well +5.8% year-to-date, justifying our overweight position in this sector. Despite the volatility, equities are only +1.3% over the same period. Our allocation to bonds is very much a tactical call and I want to make sure that we don't outstay our welcome here. However, over the next three to six months, bonds should continue to act as a safe haven asset, particularly if equities turn lower, which is what I expect will happen. 

Euro AAA bonds are currently yielding 1.1% and have a duration of approximately 7 years, which means that a 1% change in interest rates will change the value of your AAA bond investment by 7%.  Japan endured a 20 year deflationary crisis and Japanese 10 year yields bottomed at 0.50%, so Euro AAA bond yields can probably only decline by another 0.60%, meaning there is probably only 4-5% upside and multiples of that risk to the downside; a poor long term investment. However, the bonds we currently hold as a tactical position are a broader mix of Eurozone government bonds that currently yield 2.3% with a duration of 9 years. Again, we are only holding these bonds as a defensive position as stock markets appear ready to roll over.

Gold Market Update

Gold continues to show encouraging signs that its multi-year bear market is over and its bull market is about to resume. Gold bottomed in June 2013 at $1,179, rallied +22% and then declined to re-test the lows in December 2013 bottoming at $1,181. Gold shot out of the blocks in 2014 rallying over $200 to $1,392 and is now consolidating those gains. Gold is not out of the woods yet. Only a clear break and hold back above $1,525 will confirm the bull market is back. Until then, patience is warranted. 


The gold mining stocks continue to confirm the short-term bullish outlook for the precious metals. The gold mining stocks ETF GDX made a low of $22 in July 2013 and a lower low of $20.18 in December 2013 but on significantly lower selling pressure (MACD). The sellers are exhausted and I'm not surprised after a 70% peak to trough decline. The trend lower looks to be turning. If this is the case, the miners will become very profitable investments over the next couple of years.


To learn more about the full range of investment services available at Secure Investments, please contact Brian Delaney at 086 821 5911 or by email at brian.delaney@secureinvest.ie.