“On July 17th 1929, Livermore called in his whole team to discuss the state of the market.
[…]
And Livermore knew that he was the only man in America in possession of all the facts. As July drew to a close, Livermore could not have felt more bearish than he was at that moment. But still, he decided to do nothing. He knew stock markets could behave in a contrary way for very long periods of time. He did not want to move too early.
Just a half mile away, at his offices further up Fifth Avenue, Arthur Cutten was also pondering the future and coming to an entirely different conclusion from Livermore. He had the wholly opposite feeling: that Wall Street had a long way to go upwards before there was any possibility of a reaction. Cutten had made money from his bullish sentiments many times before, and they had never been wrong. He had made himself a fortune of $250 million from following those instincts.
The statistics he had in front of him, culled from official stock exchange resources, told a different story. Cutten was a student of price/earnings (p/e) ratios, a formula he had devised himself for assessing the financial value of a company. He believed that on the basis of price/earnings ratios, shares were not particularly over valued. During 1928, the after tax p/e ratio of a typical Dow Jones Industrial Average company had increased from 12 to 14, and so far, in 1929, to 15. He was also encouraged by the higher and higher dividends being paid out by quoted companies. In the first nine months of 1929, 1,436 companies had announced increased dividends. In 1928, the number was only 955 and in 1927, it was 755.
[…]
Cutten didn’t see, with figures as good as these, how shares could go anywhere but up until well into 1930.
[…]
October 28th 1929 would forever become known as Black Monday on Wall Street. The market fell 12.82 per cent, a record one-day loss on 9.2 million shares. Livermore held his nerve and didn’t buy back any of his position and instead sold another $50 million into the market but with a lot of difficulty.
[…]
Livermore’s bravery paid dividends the following day as the market crashed again and the day was christened Black Tuesday. It was another record fall as the market dropped 15 per cent at its peak and 11.73 per cent by the close.
[…]
His profit on Black Tuesday was believed to be the second biggest single day profit of anyone in history.
[…]
Bullish to the end, Cutten had lost almost everything he had, a fortune that only a week earlier had been estimated at $250 million.”
(emphasis added)
— excerpts from Jesse Livermore Boy Plunger: The Man Who Sold America Short in 1929 by Tom Rubython
[We apologise for the long excerpt but felt it necessary to share given the insights.]
It can be an uncomfortable feeling when the market does not appear to be behaving rationally. What it really reflects is that our understanding of how the market works is flawed. Viewing the market through the lens of the price-to-earnings ratio is not a sound approach to understanding the market. Do not be swayed by justifications of a market or a stock being expensive or cheap based price-to-earnings charts, especially those demarking channels or the number of standard deviations away the current estimate is from the long running mean. Markets are complex and no single indicator is sufficiently reliable enough as an investment decision making tool.
The sell-off yesterday was not because market participants collectively decided that the p/e ratio was too high.
Investment Idea: Alternative Investment Managers
Regurgitating one of our prior pieces:
“The only way for investors to have any chance of achieving their return objectives is to front-run the flow of capital into assets still generating positive yield. That is why we have had the great rush into equities the last few months and why pension funds, such as CalPERS, and university endowments, such as those managed by the Yale Investment Office, have announced they will be increasing allocations to private equity and venture capital.”
In recent weeks we have spoken with several of the investor relations teams at the leading private equity funds, institutional investors, and family offices to better understand the present dynamics within private capital markets.
The institutional investors and family offices, alike, indicated they have had a busy summer evaluating the private equity funds currently fundraising. We heard one consistent complaint from the capital allocators, they were not able to get the desired allocations with the private equity investors with enviable track records. That is, the investment managers were accepting less money than they were being offered by investors. Some investors agreed to onerous terms such as guaranteeing equal commitments to the next three funds — i.e. agreeing to invest in future funds irrespective of what transpires — to be secure allocation in a fund being offered by a investment manager in high demand.
We tried to understand from the investors why they were so eager to allocated to private equity funds. Almost unanimously the answers were:
1. Reported returns are less volatile than the returns for investments public markets given the paucity of reporting periods (2 to 4 times a year depending on the investment manager) relative to the daily mark-to-market of liquid assets. Moreover, lower volatility means that there is less explaining to do especially when something goes wrong as it did in the first quarter of this year.
2. Without (expected) private equity returns, it is unlikely the return objectives of the institution can be met.
Our investor relations contacts similarly indicated that 2020 has been one of their very best years for fundraising. Even without travel, they have been able to secure large investments from existing limited partners and attract new investors that had previously never allocated capital with them.
Alternative investment managers of the likes of KKR $KKR, Brookfield Asset Management $BAM and Blackstone Group $BX could be interesting buys if there is a deeper sell-off in US markets. We would probably avoid Carlyle Group $CG, given the challenges it has undergone following the succession of leadership from the founders to a second generation of senior executives, and Apollo Global Management $APO for reasons that we cannot yet articulate beyond stating that ‘something does not smell right’.
Thank you for reading!
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.