Broken Clocks and Hurricanes

Jul 7, 2021

Prognosticators of impending doom have often been likened to a broken clock, which is right twice a day, but not through any special skill or insight. As we emerge from the COVID Hangover, with a world awash in liquidity, Meme stocks all the rage and increased concern among at least some investors, it may be prudent to consider some of the clouds gathering.

We bear no illusion to having any greater predictive ability on timing than the above mentioned clock, but we believe that being aware of the dynamics evolving in the investment arena can help one prepare for the various potential outcomes. As readers of our missives are acutely aware, our philosophical investment perspective is built around the concept of protecting on the downside and participating on the upside. The chart below is one indicator that markets may be over extended.

Investor Credit and the Market

Net margin debt is now around $400 billion, and eclipses, by far the levels reached during the Tech Bubble . Granted, the S&P 500 is up over 150% during the intervening time period, but negative credit balances have grown by almost 300 %. Leverage in equity markets is at historically unmatched levels and reflects the massive fiscal liquidity infusion and lack of investment alternatives in the current low interest rate environment.

If one lives in a hurricane zone, it is generally wise to have a plan in place should a storm come ashore. We can ascertain from experience that equity markets can at times resemble said hurricane zone. We may not know when such a storm will occur or how serious it may be. We do, however, have a high degree of certainty that a storm will eventually occur. It may not be always necessary to board up windows and evacuate, but it is a good idea to make sure that one’s insurance is adequate and in place.

Compounding of investment returns is a very powerful concept, and diversification is deemed by many as the only free lunch in finance. We noted in a previous piece that the standard 60/40 portfolio construct may not provide investors with the protection that it has generally afforded over the last 20 or so years. With that as a backdrop, looking for insurance in other assets or strategies might make sense.

Uncorrelated assets and strategies, especially those that can enjoy many of the fruits of a rising equity market, while offering the potential of downside protection when a storm hits can be extremely valuable tools when structuring an all-weather portfolio. Hedged core equity or absolute return strategies and ETF’s that employ this approach may be a source of “hurricane” insurance that can amplify portfolio returns by limiting the damage such a storm might inflict.

Matt Thompson

Jeff Landle

CFA

Chief Investment Officer at LHA

Provided for informational purposes only and does not involve the rendering of personalized investment advice. This is not an offer to sell or a solicitation of an offer to buy an interest in any investment fund or for the provision of any investment management or advisory services. Investing involves risk. Principal loss is possible.