Is That Tail Wagging That Dog? (cont.)
I told Andrew that this sounded a lot like people blaming McDonalds for the fact that their pants don’t fit. After all, these are sophisticated investors with Ivy League educations, CFA designations and seven- to eight-figure salaries. When these investors were buying these mortgages, where was the buy side research, the responsibility to know what you own? Where was the responsibility of managers and advisers to understand the risk they were taking? Where was the credit analysis that you were taught at business school and tested on by the CFA institute?
It was not there, Andrew explained, and it still isn’t. The fact that no real research was done by so many is what caused the problem, and it has also made the problem much worse. The mortgage products that these banks created are, for the most part, doing exactly what they are supposed to do. Most mortgage securities are performing, or as the fixed income managers say, they are “money good.” In other words, these fixed income securities, which promise certain income payments, are making those payments as promised. The issue is that the market for the securities has completely gone away. It went away because all the people who were buying these securities without doing any research can’t tell which of these securities is a worthy investment and which is one of the few bad investments, so they just are not going to buy anything. When no one will buy anything, you have a crisis. And here we are.
The magnitude of this crisis has shed some light on how few people in the financial world actually do the required research that we are all taught to do. I asked Andrew if he thought we would ever learn. He laughed, and said, “We never do.”
That may be true of the market as a whole, but it is not true at Iron Capital. We do learn, and we pay very close attention to our process, to assure that the dog is indeed waging the tail and not the other way around.
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CHUCK OSBORNE, CFA, Managing Director
Market Forecast
Self-fulfilling prophesy: There will be a recession in 2008. This remains the theme. However, there are a few signs that a bottom may be near for the market, if not the economy as a whole. All self-respecting market crisis require a sacrifice, and Bear Stearns has stepped up to the plate this time around. Once the sacrifice is made, everyone starts to get serious. Banks have recently been able to obtain new capital, and money is beginning to move back into the fixed income market as many long-term investors see this as a rare opportunity to grab gains. We still believe when the dust settles the broad market will finish the year up approximately 5%.
We were right about large cap stocks over small caps and still believe that is the correct position. We were surprised about how poorly growth stocks have done and think they should bounce back, especially in the technology sector where global demand remains high.
We were right about international stocks coming back in line with domestic stocks and emerging market stocks dropping. We think those trends will continue. Our outlook for bonds remains positive. We do however believe the opportunities are shifting to the corporate bond market where a lot of babies have been thrown out with the bath water.
It is not clear that the worst is over, but of course once that is clear the opportunity for outsized gains will be gone. We believe that now is the time to ease into the high yield market.
