The Department of Justice (DOJ) announced it is suing Standard & Poor’s (S&P) over actions related to the sub-prime mortgage disaster. If you recall, investors all over the world lost billions of dollars by investing in mortgage-backed securities (MBS) to which S&P (and other ratings agencies) gave their top rating of AAA…right before those MBS’s defaulted. The problem, it seems, is that the ratings agencies were being compensated by the companies who were creating and issuing the same MBS’s that the agencies were rating. Kind of a “You scratch my back – I’ll scratch your back. Then we will shoot those other guys in the back” type of arrangement.
We don’t know if the DOJ will pursue action against Moody’s and Fitch (the other major ratings agencies), but they probably shouldn’t get too comfortable. In addition to the DOJ, my bet is that many states’ attorneys general will be lining up to get in on the action. When attorneys smell blood…
I’m not a legal expert so I won’t speculate if the ratings agencies are guilty of actions which could cost them hundreds of millions of dollars in civil penalties. (But no jail time of course. What were you thinking?)However, I wrote about them in my February 2011 Investment Commentary “No Food? Give Us a New Leader!“ and if nothing else, they are certainly guilty of stupidity and incompetence.
What is not likely to be part of government testimony is the stupidity of investors all over the world who relied on the ratings of S&P, Moody’s and Fitch as their primary (maybe sole) source of information when making an investment. The laziness, etc. of many “professional investment managers” who rely almost exclusively on ratings for security selection is pathetic. When you are managing money for a living, you have to know how to assess and value the merits of any investment on your own – not rely on a ratings agency. There’s an old saying, “Those who can’t do, teach. Those who can’t teach get jobs at ratings agencies.” (My apologies to teachers everywhere…except my junior high social studies teacher.)
At Boyer & Corporon Wealth Management, we dig a little deeper. If a security is sporting an AAA rating (or AA), it might pique our interest, causing us to dig deeper…looking for potential red flags. With sub-prime, non-agency MBS’s, we found enough red flags to avoid investing even one penny in ANY of them. We weren’t smart enough to “short” them but we managed to avoid investing in them. So we don’t feel the need to sue S&P for their stupidity, their incompetence or even their alleged misconduct. We never gave them that much credit in the first place. And we don’t feel a bit sorry for all the “professional” investors who lost millions relying solely on S&P’s ratings.
So who is going to sue the “professional” investment managers who relied solely on the ratings of S&P, Moody’s and Fitch?
For the past couple of years, I have been noting in several Investment Commentaries that we were finding unusual value in municipal bonds. In particular, municipal bonds issued by municipalities in California…particularly zero-coupon municipal bonds from those cities and school districts. Wall Street “experts” had predicted the demise of cities in California as well as a massive wave of municipal defaults. This foreboding forecast caused investors to dump those bonds at virtually any price.
We thought Wall Street fears were overblown and took advantage of those depressed prices. We increased our allocation to California zero-coupon municipal bonds…increased it to more than double our typical allocation. Gradually, from January 2011 through the present, we have experienced a “party” in municipal bond performance. It has been the best performing asset class of all our investments and has provided a pleasant boost to overall performance.
However, I’m here to tell you that the party is almost over. The food is gone. The band has stopped playing and they are beginning to remove the centerpieces from all the tables. We have been gradually liquidating our positions in California zero-coupon municipal bonds. We still have an allocation but it is much smaller than it was one year ago. Our task now is to begin searching for the next “party.” No, I don’t know where that party is yet.
Last March, I noted in “Beware the Ides” that Apple® was trading at such a lofty level ($550 billion) that it was worth more than 11 companies in the Dow Jones Industrial Average COMBINED. I stated that Apple was not “relatively cheap” but that it might go even higher. And we trimmed our positions at $582 per share.
Over the next six months, Apple increased in value to above $700 per share and a market capitalization of over $700 billion. No, I didn’t look very smart then. That’s the unfortunate thing about our business – you can be right but look wrong for a long time before you ARE finally correct. It’s very frustrating. Investors were convinced Apple could do no wrong and that it just didn’t matter what one paid for the stock because it would always go higher.
Since then, of course, Apple has traded as low as $440, down 37% from its high, proving once again that you can purchase stock in a great company and lose your butt if you paid too much for the stock.
January proved to be a better stock market month than we expected…and we were expecting it to be good (see January Investment Commentary “Buy and Hold?”). Major global stock markets increased more than 5% in January as corporate earnings for the fourth quarter of 2012 were not a disappointment and global “uncertainties” became virtually non-existent.
Investors are MUCH less skittish than they were seven months ago and they have temporarily exchanged trepidation for complacency. Stock markets love complacency and the current environment is about as complacent as it can get. It was only eight months ago when we had all sorts of uncertainties…and trepidation.
Last year at the end of May, investors were so confident that Greece would default on its debt that Greek 10-year bonds were trading with a yield of 29%. Today, investors are only demanding a yield of 10.6% in exchange for loaning money to Greece. What happened? Did Greece get their financial act together in that short period of time? No, but it has ceased being a global uncertainty for now.
Three months ago we were wondering who would live in the White House for the next four years and if we would fall over the fiscal cliff. Obama was re-elected…Obamacare (all 906 pages of it) is here to stay. And, no, we did not fall over the fiscal cliff and die.
The biggest uncertainty facing investors today is the debt ceiling debate and sequestration. If those are the largest uncertainties facing investors, I would rather be IN the stock market than OUT. It’s only February and I’m sure that later in the year, some global uncertainties will make themselves apparent. Until then, we continue to have an increased allocation to equity.
This information is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.