Will it be a “bearish” summer?

June 15, 2012

Lately, the weaker-than-expected economic data globally and the deepening of the European sovereign debt crisis have prompted market observers to sound the warning bells for a bear market. Some are comparing the current downdraft to what happened in 2010 and 2011, implying much further downside. Others—including international policy makers—have compared the current environment to the summer of 2008, likening the fall of Lehman Brothers to a Greek exit from the eurozone and emphasizing the unknowable “unknowns” and the spillover effects that could follow such an exit.

It seems as though a bearish sentiment has become increasingly pervasive. The American Association of Individual Investors’ sentiment survey has shown a significant increase in bearish sentiment in recent weeks. From our perspective, this level of bearishness is in sharp contrast to the year-to-date total return of 2.6% in U.S. equities! So the question is…whether such bearishness is warranted.

We are highly skeptical of the “doom-and-gloomers” or any forecaster with a strong view of how markets will perform in the near future. Markets and the events that shock markets are nearly impossible to predict on a consistent basis. A broader review of the economic data seems to indicate that while the U.S. economy might be in another “soft patch,” there is still meaningfully positive growth and that growth is likely to continue.

The media is focusing on Europe as the potential catalyst to knock the United States off its path of positive growth; we view this as unlikely. While peripheral Europe has serious solvency and liquidity issues, core Europe is growing and is not in recession, which gives Germany and France room to act to stabilize the economy. Political actions are almost as difficult to predict as the markets; however, the cost of a eurozone breakup would be much greater than the cost of a bailout to the core European countries. So if core Europe acts rationally, it’s difficult to imagine that the European Union would break up, even if it means large additional bailouts or, more likely, major structural reform.

Furthermore, Greece is relatively insignificant. A Greek exit could send a troubling message and start the game of “who’s next,” but on its own, it is a non-event. And, we believe that a Greek exit is unlikely. Returning to the Drachma doesn’t solve any of Greece’s problems; in fact, it enhances them by leading to potential hyperinflation and restrictive capital controls, making an exit even more unlikely. 

So while it might feel reminiscent of the summers of 2008, 2010 and 2011, it’s the summer of 2012. The situation today is materially different from those of previous years. The United States is growing, core Europe is creatively (if too slowly) dealing with the problems of the peripheral countries, and central banks around the world are working to coordinate and promote growth. Overall, the data indicates a heightened level of concern, but nothing that should distract us from staying focused on the long term.

Wealth Enhancement Group


ANATOMY OF AN IPO

June 7, 2012

Initial public offerings (IPOs) are associated in investors’ minds with enormous profits. These profits, however, tend to be more for the founders of companies and for investment banks rather than for retail investors or even institutional investors. Market observers always call to mind a few “hot” IPOs where the share price provided double-digit returns in a single day.
 
But what happens after the initial excitement? Studies have shown that, in general, investors are better off owning shares of seasoned companies as opposed to new issues through an IPO. While we don’t know for sure why investors overpay for IPOs, research also indicates that investors overweight the probability of extreme growth of newly listed companies and therefore apply too high a value to these shares.*
 
That brings us to the recent Facebook IPO. We don’t know if Facebook is fairly valued or not. We generally believe that the market fairly prices liquidly traded securities and therefore we do not believe we have much edge or insight into the valuation of any one issue. Given our belief that large, liquid stocks are generally fairly priced, and because of the long-term underperformance of IPOs, as a firm, Wealth Enhancement Group did not participate in the Facebook IPO and we advised our clients against participation as well. In general, we advise against participation in any IPO.
 
Not having edge or insight into publicly traded stocks sounds like a bad thing, but it’s actually a good thing. When all market participants are working with the same information, it limits the ability of more-informed market participants to take advantage of less-informed participants, who unfortunately tend to be working savers or retirees. In the case of the Facebook IPO, there have been allegations that not every investor had the same information. According to press reports, certain investment banks changed their forecasts for Facebook and communicated those changes only to institutional clients, leaving individual investors—their retail clients—in the dark. The effect was that those retail clients may have paid more than they would have otherwise been willing to pay for the Facebook shares. While we don’t know yet what happened at Facebook, we do know that the more widely information is disseminated, the better for individual investors, our clients and the functioning of the market as a whole.
 
Wealth Enhancement Group
 
*Ritter, Jay, 1991, The long run performance of IPOs, Journal of Finance 46, 3-q7.