Most Popular
1. Dow Max Drawdown Bear Stock Market 2022 - Accumulating Deviations from the Highs - 21st Feb 22
2.Putin Starts WW3 in Ukraine, Will Use Tactical Nuclear Weapons, China Prepares Taiwan Blitzkrieg - 28th Feb 22
3.World War 3 Phase 1 - Putin WINS Ukraine War! - 25th Feb 22
4.INVESTORS SEDUCED by CNBC and the STOCK CHARTS COMPLETELY MISS the BIG PICTURE! - 10th Feb 22
5.Will There Be A 2024 US Presidential Election? - 3rd Mar 22
6.Gold and SIlver, Precious Metals Sector Is at a Terrific Buy Spot - 6th Feb 22
7.Why Putin Wants the WHOLE of Ukraine - World War 3 Untended Consequences - 6th Feb 22
8.Dow Stock Market Expected Max Drawdown 2022 - 19th Feb 22
9.Stock Market Calm In the Eye of the Inflation Storm - 4th Mar 22
10.M = F - Everything is Waving! Stock Market Forward Guidance - 7th Mar 22
Last 7 days
How Low Could the Amazon (AMZN) Stock Price Fall? - 19th May 22
Bitten by FANG? Clocked by Cryptos? -- 'Air Pockets' Everywhere - 19th May 22
Northern General Hospital Orthopedics Fractures and and Ankle Clinic Consultations Real Patient Experience - 19th May 22
Cathie Wood Goes All in on Teladoc, ARKK INSANE Noob Investing Strategy! - 17th May 22
This is Anything but Positive for US Housing Market - 17th May 22
What Should We Do If There Is No Fed Monetary Policy Pivot? - 17th May 22
All Possible Ways to Earn Free Litecoin - 17th May 22
How low Could the Amazon Stock Price Fall? - 16th May 22
Cathy Wood ARKK INSANITY There is NO Coming Back! - 16th May 22
NASDAQ 100 Stock Market LOWER LOWS & LOWER HIGH - 16th May 22
Sanctions, trade wars worsen US inflation - 16th May 22
AI Tech Stocks Earnings BloodBath Buying Opportunity - 14th May 22
Futures Contract – Trading Crude Oil With USO - 14th May 22
How to Get Kaspersky Internet Security for 80% Discount! Do not Pay Renewal Price! - 14th May 22
Sagittarius A* Super Massive Black Hole Monster at Centre of Our Galaxy REVEALED! - 14th May 22
UK Public Debt Smoking Inflation Gun - 13th May 22
What Happens When the Stock Market Dip Keeps Dipping? - 13th May 22
Biden Seeks Inflation Scapegoats; Gold Advocate Wins GOP Primary - 13th May 22
Apple and Microsoft Nuts Are About to CRACK and Send Stock Market Sharply Lower - 12th May 22
The War on Gold Ensures the Dollar’s Downfall - 12th May 22
Crypto Investors Stable Coins TERROR as Terra USD COLLAPSEs towards ZERO, Tether Next! - 11th May 22
INFLATION IS KILLING SILVER - 11th May 22
The Dominant Investing Theme of the Decade - 11th May 22
Is Bitcoin Headed to Zero? - 11th May 22
RECESSION RISKS 2023 - 10th May 22
The Future of the Dollar Seems So Bright It’s Blinding Gold - 10th May 22
Take Advantage When Markets Succumb to Fear - 10th May 22
How to Recognize a Less\ Than Obvious Opportunity (In focus: Corn) - 10th May 22
How to Ensure Financial Stability for Your Family - 10th May 22
The Stocks Stealth BEAR Market - 9th May 22
A Strengthening US Dollar Is A Double-Edged Sword - 9th May 22
Making Wise Investment Decisions - 9th May 22
Ways to legalize a Moving Company - 9th May 22

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Investing and the Passive Management Bubble

Companies / Investing 2014 Dec 16, 2014 - 03:33 AM GMT

By: Michael_Pento

Companies

We have happened upon that time in the investment cycle when investors vastly eschew active management of their assets in favor of a more passive management style. In fact, I read recently 461 Hedge Funds, a hallmark of active investment management, shut their doors in the first half of this year alone. If liquidations continue at that rate, they'll outpace the 1,023-closure record from 2009. All signs now indicate that active management has fallen out of vogue.


And why wouldn't it? Index funds have done very well these past few years; whereas active managers have underperformed the major averages. The problem is when everyone piles into or out of the same investment philosophy, it usually signals it's time to change course. Therefore, I predict the tides will soon change and active management will make a huge comeback.

Passive investing, such as Index mutual funds, is an easily understood investing style that allows you to access broad segments of the market. Indexing has been called investing on autopilot. This is a strategy that tends to work well, until it doesn't. Take the mid to late 90's, when it appeared the stock market would always go up. Everyone from your hairdresser to the cab driver was a stock genius. New websites such as the Motley Fool preached that you didn't need an investment advisor--just buy a broad basket of stocks (especially in the technology sector) and you would get rich. And, if got out before March 10, 2000, you were all set.

However, if you failed to get out then, we all know what happened--your portfolio quickly crashed and caused the loss of $5 trillion in the market value of companies from March 2000 to October 2002. During this time, only managers who offered a long/short and dynamic asset allocation strategy produced positive returns.

Another feature of the passive investment approach argues that you don't have to actively manage your investments as long as you stay diversified. This is referred to as the Modern Portfolio Theory (MPT). MPT is a mathematical formulation that creates diversification in investing, with the aim of selecting an assortment of investment assets that have a collectively lower risk than any individual asset. This is possible, so the theory goes, because different types of assets often change in value in opposite ways. For example, the stock market often moves in the different direction from yields in the bond market. Therefore, a pool of both types of assets can nearly always (in theory) offer lower overall risk than holding just one asset class exclusively.

But this doesn't always work. Consider the 1970's, a time when stock prices fell, while bond yields soared. Investors who remember the protracted bear market of 1970-1982, know that during this time both stocks and bond prices went down in tandem.

During the 1960's, investors were persuaded to enter into a basket of large-cap stocks called the Nifty Fifty. If they were diversified, as the MPT suggested, they would have also been in bonds yielding around 4%-5%. The Nifty Fifty coupled with your 4%-5% bond would have worked pretty well during this time period, until it didn't. Holding this diversified portfolio would have left you in a house of pain during the mid and late 1970's, as the S&P 500 dropped around 50% and the Ten-year Treasury note went from 4%, to over 15% by 1981. The stagflation in the 1970's caused both stocks and bonds to fall in tandem.

So where are we now? I have stated for a while that it is my belief the United States -- along with the rest of the developed world--are facing an entirely new paradigm. Namely, that such onerous and record debt levels have now reached a point where government revenue will become woefully insufficient once interest rates normalize. Therefore, the developed world must choose the manner in which they will default on the debt. Central banks will be forced to either monetize mountains of debt, or allow a deflationary depression to wipe out the economy.

With bond yields already at historic lows, brought about artificially by massive central bank manipulation of bond prices, the next time a recession occurs it is much more likely we will have a debt crisis due to a lack of revenue available to service government debt.

The European bond crisis was all about such a fiscal disaster, not the prevailing rate of inflation at that time. Investors did not flock into the "safety" of bonds during their financial crisis of 2008. Instead, the Greek 10-year Note, which averaged around 5% just prior to the crisis, soared to near 40% by March 2012. However, the rate of inflation averaged just 1.5% during that same time frame. Bond yields soared because owners of sovereign debt became assured that Greece would either have to pay investors back in worthless currency or renege on the principal and interest of its debt. As it turns out, Greece used both methods of default.

A true fiscal crisis always leads to sovereign default -- either through inflation, a debt restructuring or both. Another recession similar to the Debt Crisis of 2008 will most likely bring down both stock and bond prices. Only this collapse in bond prices may not be caused by inflation right away, but instead will be the result of a severe revenue dearth due to a collapsing economy. A diversified portfolio of Index and bond funds will not provide much security in this case.

The easy monetary policies of global central banks have not only brought about serial asset bubbles, but these market manipulators have also created a new bubble...one where most investors have been lulled to sleep with a false feeling of comfort. What they believe to be a diversified portfolio may instead prove to be a group of highly-correlated asset classes.

These investors are also convinced that they have become buy and hold geniuses, duped by central banks into believing the passive management style of investing can never fail. But if stock and bond prices plunge together in the next recession, investors will then flock back into the active management style of investing, as they realize the need to have a manager that can not only move between asset classes (including precious metals), but also has the flexibility to profit from a decline in the market.

Michael Pento is the President and Founder of Pento Portfolio Strategies and Author of the book “The Coming Bond Market Collapse.”

Respectfully,

Michael Pento
President
Pento Portfolio Strategies
www.pentoport.com
mpento@pentoport.com

Twitter@ michaelpento1
(O) 732-203-1333
(M) 732- 213-1295

Michael Pento is the President and Founder of Pento Portfolio Strategies (PPS). PPS is a Registered Investment Advisory Firm that provides money management services and research for individual and institutional clients.

Michael is a well-established specialist in markets and economics and a regular guest on CNBC, CNN, Bloomberg, FOX Business News and other international media outlets. His market analysis can also be read in most major financial publications, including the Wall Street Journal. He also acts as a Financial Columnist for Forbes, Contributor to thestreet.com and is a blogger at the Huffington Post.
               
Prior to starting PPS, Michael served as a senior economist and vice president of the managed products division of Euro Pacific Capital. There, he also led an external sales division that marketed their managed products to outside broker-dealers and registered investment advisors. 
       
Additionally, Michael has worked at an investment advisory firm where he helped create ETFs and UITs that were sold throughout Wall Street.  Earlier in his career he spent two years on the floor of the New York Stock Exchange.  He has carried series 7, 63, 65, 55 and Life and Health Insurance Licenses. Michael Pento graduated from Rowan University in 1991.
       

© 2014 Copyright Michael Pento - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Michael Pento Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in