Persevere. I can’t tell you when the turn will be, but it is getting closer

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Persevere. I can’t tell you when the turn will be, but it is getting closer
<a href="https://pixabay.com/users/kulinetto/">kulinetto</a> / Pixabay

This should be a brief article. I remember back in 1999 to early 2000 how P&C insurance stocks, and other boring slower-growth industries were falling in price despite growing net worth, and reasonable earnings. I was working for The St. Paul at the time (a Property & Casualty Insurer), and for an investment actuary like me, who grew up in the life insurance business it was interesting to see the different philosophy of the industry. Shorter-duration products make competition more obvious, making downturns uglier.

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The market in 1999-2000 got narrow. Few groups and few stocks were leading the rise. Performance-conscious investors, amateur and professional, servants of the “Church of What’s Working Now,” sold their holdings in the slower growing companies to buy the shares of faster growing companies, with little attention to valuation differences.

I remember flipping the chart of the S&P 1500 Supercomposite for P&C Insurers, and laying it on top of an index of the dot-com stocks. They looked like twins separated at birth, except one was upside down.

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When shares are sold, they don’t just disappear. Someone buys them. In this case, P&C firms bought back their own stock, as did industry insiders, and value investors — what few remained. When managed well, P&C insurance is a nice, predictable business that throws of reliable profits, and is just complex enough to scare away a decent number of potential investors. The scare is partially due to the effect that it is not always well-managed, and not everyone can figure out who the good managers are.

So shares migrate. Those that fall in the midst of a rally, despite decent economics, get bought by long-term investors. The hot stocks get bought by shorter-term investors, who follow the momentum. This continues until the gravitational effects of relative valuations gets too great — the cash flows of the hot stocks do not justify the valuations.

Then performance reverts, and what was bad becomes good, and good bad, but as with almost every investment strategy you have to survive until the turn, and if the assets run from the prior migration, it is cold comfort to be right eventually.

As an aside, this is part of what fuels dollar-weighted returns being lower than time-weighted returns. The hot money migration buys high, and sells low.

Thus I say to value investors, “Persevere. I can’t tell you when the turn will be, but it is getting closer.”

Article by David J. Merkel, CFA, FSA - The Aleph Blog

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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