Investment Management Structural
Change Thoughts and History (Part 1)
There have been numerous times in my career that the way the “real” world unfolds seems to be at odds with the “financial” world. Working through those times requires patience and process.
Other times, there are rational connections between the real and financial worlds. Those times are easier to navigate as an advisor.
Let me share a story with you about some of the steps I have taken in terms of investment process over the years.
When one starts in the investment industry, you really have no idea what you are doing. You think you know…but you don’t! That’s why large investment companies like RBC Dominion Securities have so many supports and managed solutions to allow new advisors to run professional businesses.
As time progresses, advisors choose to either stay completely managed under their employer’s suite of services or take some amount of their client’s money and find more targeted financial solutions.
When I started in the 1980s the suite of investment services offered was nowhere near as comprehensive as it is now, so EVERYONE had to find their own niche. My niche (that took 4 years to figure out) was a unique blend of fundamental and technical analysis.
From 1988 to 2009 that blend worked quite well. But during the recovery from the mortgage meltdown of 2009/2010 something began to change in the structure of financial markets. The old blend of fundamental and technical analysis stopped functioning as efficiently as it once did in my process.
With a lot of diligent study and observation, I figured out that financial “liquidity” was much higher post 2009 and it made the financial markets behave differently. Adjustments were made to my process and liquidity became one of the metrics I incorporated.
The challenge in trying to use liquidity as a metric is that the providers of liquidity are small groups of people that can change their minds overnight. The risk is they would change policy direction (liquidity injection) and financial markets would stop going up on the loss of liquidity.
By the time we got to the 2016 Trump-win election in the US, it was clear the economy’s liquidity-addiction was here to stay. The negative side effects (growing debt and rising cost of living) were problems to be kicked down the road for someone else to sort out.
My investment process had more inputs than it did in the 1988-2009, so it felt a little “lose” compared to what I had modeled prior to 2009. That said, it was adequate in terms of balancing risks and rewards in the 2011-2019 period.
Of course, the COVID crisis of 2020 created a set of financial conditions that no model was built to compensate for. The moves from late January 2020 until May 2020 were impossible to model. By June 2020 it was clear that the “hyper-liquidity” injected into the financial world during the pandemic was just the same liquidity model the world had endured before 2020…on steroids.
The last half of 2020 and the first 9 months of 2021 was the most profitable time for investors net worth in the past 75 years! Bonds went up, real estate went up, stock markets went up…and for those daring enough with capital to spare, there were “meme stocks, crypto, NFTs, fine art, sports franchises, etc. to make absolute fortunes in. (Last weekend’s email showing the net worth percentiles for 2023 stands as evidence of this fact).
When the COVID liquidity bubble finally peaked in November 2021 it was obvious the markets were out of control in terms of price and liquidity. The central banks were miles behind the curve in terms of raising interest rates to combat “transitory inflation.” The time had come for liquidity to contract, and interest rates to be lifted.
It was hard for people to believe the music was in the process of stopping and the dance was over. The time from the November 2021 market peak and the technical signal it was “over” in late February 2022 was a time where investors who profited most in the bubble gave some of their bubble-gains back to the market-gods as tribute trying to “buy the dips.” (That was certainly me!)
In February 2022 I wrote that investors should expect a possible 30% decline and ask themselves whether they want to hold through another quick drop and run higher.
In March 2022 I recommending selling down to your minimum stock market exposure and adding some mid-dated government bonds.
The financial markets were, once again, in completely new territory in terms of asset prices, interest rate levels and the levels of liquidity being served up by the central banks. The correction in bonds, stocks, and real estate from November 2021 to the bottom in October 2023 was nasty. Not all asset classes have recovered yet, so the process is ongoing today.
Since the beginning of the COVID era of investing in 2020, I have tried to do my job through the investment process lens that has served me reasonably well since 2009: Liquidity influenced, fundamental and technical analysis. But just like in 2009-2011 something was continually not working the same in my process. The results were becoming more erratic. It was time to tweak the model again.
The first step in tweaking is looking to see what had changed. Since 2020, the number of things that have changed is a long list. So that wasn’t a fruitful pathway to go down. There were just too many variables.
My next step was to start reading books and articles written by people asking the same questions that I was. This was a comforting step…I was not alone. Not even remotely alone!
Zeroing in on the financial markets themselves there were two main themes being written about as to why they had changed.
- Artificial Intelligence (AI) being used at every level of financial engineering and management. Much of the AI investment influence is targeted in the options and derivatives markets.
- Passive investment growth as a percentage of total investments made.
In part 2 of this editorial, I will delve deeper into these and a few more topics in more detail.
For this overview, it will suffice to say, I needed to find a way to a process to handicap the two variables mentioned above. I will save the rest of this story for the next installment.
To wrap up part 1, let me summarize where my investment process has landed in the past year.
I choose to view a client’s investible assets in one of three buckets:
- Fixed income, GICs, preferred shares, and money market (cash).
- Dividend income producing common shares.
- Risk managed growth.
The first two bucket prospects are improved in the post 2023 financial conditions. The management of assets in buckets 1 and 2 has not required tweaking due to the changes in the financial world since COVID.
Money in short term deposits now pays a person 5% rather than 0.50%. Yes, inflation is higher but making a return on risk free cash is a welcome improvement.
Dividend producing common shares are lower in price, and therefore, paying higher dividend yields. As long as they keep paying their dividends, they make for solid long term income providing solutions.
Bucket #3 is a whole new ball game!
My old process of liquidity, fundamental and technical analysis is obsolete in 2024. Artificial Intelligence and passive investing have changed the structure of investing success.
One teaser chart for next week….
I wish I had a chart that showed this up to the present rather than just the end of 2022. I’ll dig something up before part 2.
Think about what that chart is saying: 44% of the trading volume of the S&P500 was represented by option contracts expiring in less than 24 hours!
The chart clearly shows how different that single fact is from 5-10 years ago!
Let’s end it here and stay tuned for part 2 next time…