Keep some powder dry ("liquidity") for 2016 private & public equity opportunities.

1. Through 2007 many public companies' share prices were higher due to use of leverage (debt) and the "artificially-rich" middle class (using home equity loans) playing the market as most investments seemed only to increase in value.  This was despite many companies' actual specific performance.

2.  Then in 2008 and 2009, these retail investors after seeing much of their windfall and principal erode sought the "safety" of low yields where earnings were 1/100% or 1/10% on every dollar against the backdrop of a 2% inflation rate.  No way, with those returns, were they going to recoup their equity losses.

3.  Our U.S. government, created market liquidity and velocity, when both banks and corporations could or would not embrace an equitable fiscal policy.  The U.S. "printed" (electronically) trillions of dollars and injected this massive sum into our economy.  These funds made a Wall Street detour, which transferred the massive debt onto the federal government (that would be you and me).  Institutional investors having taken a heavy hit to their investments returned to the market to get their share.

4.  Despite the global financial malaise (and likely due to abundant shale and a glut of cheap oil) more affluent families and companies are now "reporting" better results ("wealth income") because all those dollars flooding the market were injected into the equities eventually creating "performance" at or exceeding 2007 levels.  A "rebound".... using deflated dollars.  We dodged a bullet as the balance of industrialized nations did the same thing... just later.  Now most nations ~ i.e., taxpayers, have taken on additional debt.  And finally, an influx of retail investors arrived late to the party trying to restore their losses.

5.  While the low interest rate environment wasn't so great for folks on fixed income and savers; it has been a boon to working families, corporations and for the housing market.  Who doesn't want a low-interest, new car or 65" flat screen television on credit?  (Yet, credit card rates haven't declined and balances have risen after folks resuming their past buying sprees.) But these prices and rates are artificial contrivances with no correlation with risks that influence their levels.  As rates rise, home pricing gains will slow and so may our economy. 

6.  Wall Street has little to do with main street.  Modern portfolio theory has almost nothing to do with individual company performance; hence, the distinction between a market of stocks and the stock market.  The former requires due diligence and deep analytics.  Do institutional investors, who represent the majority of daily trades, really believe the daily pundits of what's causing the market's rise or fall?  What does quarterly results have to do with legitimate mid- and long-term performance/market risk?  If 2007 share prices were a result of corporate debt, what is driving the high share prices now? 

7.  Are GOP members fiscal conservatives, when the left uses higher taxes and the right uses debt to pay for what special interests want?  Both presidential candidates, after the primaries, will feed from the Wall Street trough. Somehow they'll convince the working- and middle-class who comprise the majority of the electorate and are struggling to support their families and pay for their kids' higher education or vocational training that their parties' fiscal policies will be job creators.  And about tax policy.  Wasn't there a time when big corporations were more patriotic as they paid a larger portion of the federal tax bill thatsupports their ability to benefit from our U.S. infrastructure?  Nay, the conversation has devolved into a "wag the dog" perversion where the battle lines are the 1% versus everyone else instead of corporates' paying a fair share.  Lest we forget, entrepreneurs make up a disproportionate amount of the 1%.  They're creating jobs for people who will then pay federal, state, local and sales taxes versus receiving governmental assistance.  That's real trickle down economics filling the void left by big corporations that decided to offshore jobs and profits.  The rightful debate is how low should entrepreneurial companies' taxes be since much of their innovation is the real economic engine of the USofA. 

8.  If Warren Buffet's selections have the Midas touch, why don't most follow his selections with the same net returns?  Because he uses a major insurance company that shields most taxes and selects "boring" dependable companies whose steady growth compounds.  Who needs homeruns if you can double the value with steady growth every six years?  His own estate plan and two Economics Nobel Laureates have indicated index funds are the best hedge for buy-and-hold and low load (costs)  investors.  This is why Vanguard is the fund behemoth it is and market timing has been elusive at best.

9. So, what does this have to do with keeping powder dry?  Most investment bankers know there has been a steady decline in many sectors for midmarket company transactions since 2H15.  Yet, too much cash chasing too few deals has kept values inflated.  Then there's the herd of institutional advisors endeavoring to attract the mildly or more wealthy to follow a common path creating a self-fulfilling prophecy of often marginal, below index performance as the majority can't all be "right" on the buy or sell side of a transaction.  Seldom does conventional wisdom create massive wealth (but it can result in a good deal of commissionable trades and allocations).  Ask any entrepreneur who daily manages concentrated risk.  It is they, contrarian value and activist investors digging deeper who exceed index returns.  Institutions tell them they'll revert back to the mean (eventually lose principal value) and the sacrifice liquidity.  If they have grown wealth for 25 years obviously this refutes the first argument and while illiquidity might be preferred is it over maintaining control and often teen- and twenty-something percent year-over-year returns.  Any wonder, the ultra-wealthy are migrating to direct investment in private equity; acquiring larger blocks of public stock to gain board seats or seeking to delist publics to get better returns?  For goodness sake, that's why they're wealthy clients!  If the music stops, creating illiquidity and a downward pressure on equities, 2016 is likely to be a buyers' market.... And they will be ruthlessly compassionate!

10. If the market correction is more abrupt than in 2008, many opportunities will be abound in the broader market.  Yet, many $50 - $500 million companies (public and private) are already fairly priced or below market because they're thinly traded or private.  (LINK) This due diligence and operator skills is not simply a matter of financial engineering.  Often values are influenced by board and management decisions with an almost slavish focus on revenues, profits and taxes, instead of the risks that can often most influence equity price multiples.  I wrote an entire book that has less to do with valuing equity and more to do with how trusted advisors working collaboratively and in alignment with their clients could change the paradigm of Wall Street remaining the focus of business news, but you'd have to shell out $85 on the book and be willing to coax those with whom you have influence to try something different by taking their own paths.

Am I being a prognosticator, a pragmatist or a pundit?  What does your crystal ball say?  I hope it says "share this guy's post, connect with him on LinkedIn, buy his book or contact him about how to leverage his knowledge. 

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