The investment environment has become like ‘picking up pennies in front of a steamroller’, says Robeco’s Lukas Daalder.
“Most asset classes have shown a fair performance during the first five months of the year, so that means overall returns have certainly been positive so far,” says Daalder, Chief Investment Officer of Robeco Investment Solutions. “Despite all the political tensions, the high valuations of US stocks, the uncertain economic outlook, and even the wrong season (‘Sell in May’), stocks want to move higher.”
“The current environment feels a lot like picking up pennies in front of a steamroller: a reasonable probability of modest and steady gains, but a non-negligible probability of a big loss up ahead. The question for us is do we want to be in the business of picking up pennies in front of a steamroller?”
The term `picking up pennies in front of a steamroller’ is linked to Nassim Taleb, an acclaimed author on randomness and risk, whose books describe an investment strategy that has a high probability to yield a small return (pennies), and a small probability of a very large loss (steamroller). Taleb assumed that the negative outcome scenario would on balance outweigh the pennies picked up.
“The latter is certainly true in case of the steamroller (certain death), but in financial markets, much will depend on long you are successful in picking up the pennies unharmed, or how fast you can exit the market,” says Daalder. “For sure, entering the stock market at the wrong time (near the top) can give you the feeling that you have been hit by a steamroller once the correction starts: your losses are likely to outweigh your gains.”
So far, the penny picking has been the clear winner
“Having said that, for the broader stock markets, it should be pointed out that the longer-term nominal annual return has been around 8%, indicating that so far, the penny picking has been the clear winner. As such, the metaphor seems to oversell the downside.”
“Indeed, as foolish as the penny-picking may sound, it should be pointed out that it has been a very profitable strategy in most markets during the post-crisis years. Investing in high yield and credits have given investors a steady bit of extra return (spread) at the risk of a big credit event (such as a default) taking place. With the exception of the US oil sector, no big credit event has occurred, with spreads either remaining steady or even declining.”
“Stocks markets on the other hand have drifted higher, and although there has been a bit of volatility at times, the big steamroller has not been hitting the paving stones. It has been pointed out by many that buying volatility (by buying the VIX index, for example) has been a steady money maker, while selling volatility (or buying protection, by selling the VIX) has resulted in a constant drain.”
Daalder says there are a number of reasons for this anomaly, led by the fact that central banks have moved from being a shepherd of the economy to a general guardian of the financial markets. Meanwhile, economic growth may have disappointed over the past five years, but this has come on the back of lower volatility of the underlying data.
In addition, a long list of political wobbles has not moved the markets all that much. “The lesson seems to have been that simply ignoring those uncertainties was the optimal outcome,” Daalder says. “This is not to say that this is correct: it is always possible that one of the uncertainties escalates.”
“Another way to address the nickel-picking question, is by looking at two related questions: how big is the steamroller and are we talking pennies, dimes or dollars here?” Daalder asks. “With US stocks markets rebounding by 225% from their 2009 low (including dividends, the annual return has been 18% over that period), and with US stocks now looking expensive according to a whole range of valuation measures, it is clear that the easy picking has already been done.”
“This is exactly the reason why we prefer to be overweight the European market, where we think there is more upside after a more muted market recovery since 2009 (up 80%, resulting in an annualized total return of 12%). Further upside for US stock markets is therefore closely linked to earnings growth. All things considered, the most likely outcome would be a ‘healthy’ 10% correction in stocks, not the real steamroller event.”
“Subsequently, we have so far refrained from entering the business of penny-picking in the stock market: emerging market debt and high yield have been our preferred asset classes with which to add risk so far. If we were to put up an overweight position in stocks, it would be completely momentum driven, and with a pretty tight stop-loss put in place.”
The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.
The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.
Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is ACOLIN Fund Services AG, Affolternstrasse 56, 8050 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.
Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/RobecoSAM AG product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/RobecoSAM AG offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.
This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.