No, sir. Geist and Ende were the outliers at FPA for years. While the rest of FPA were hard-core absolute value guys, G&E ran splendid small to mid cap growth funds, fully invested in very high-quality companies, negligible turnover, drifted between small and mid, growth and blend. Returns were consistent and solid.
The funds were F P A Paramount (FPRAX), F P A Perennial (FPPFX) and the closed-end Source Capital (SOR), and they were pretty much clones. F P A decided, about a year ago, for whatever reason, to take FPRAX from the guys and convert it to a global all-cap absolute value fund. Now FPPFX is becoming the U S version of Paramount, it seems.
But ... Geist did retire in 2014 and Ende, at age 70, is moving toward the door. Greg Herr, more of a Romick-type guy, was added to the team several years ago, presumably in anticipation of the transition.
Two reasons to sell:
1. the new fund will likely have nothing in common with the old. If you had a reason for buying Perennial before, it's gone now.
2. the tax hit will be substantial. Morningstar calculates your potential capital gains exposure at 63%, that is, 63% of the fund's NAV is a result of so far untaxed capital gains. If the portfolio is liquidated, you could see up to $36/share in taxable distributions. During the Paramount transition, the fund paid out about 40% of its NAV in taxable gains including two large distributions in two weeks.
Certainly the tax hit will vary based on your cost basis, but my as-yet uninformed guess is that if your cost basis is high - $35/share or more - you might be better getting out before the big tax hit comes.
But, really, I'm not a tax guy. That's just a superficial take on it.
David

"The challenge of asset allocation now is no longer having too few ingredients to consider but rather selecting among an ever increasing array of sector-specific mutual funds and exotic ETFs"
A Seven Asset Portfolio out performed all other asset allocations, both prior to and during retirement.
This would consist of:
-large-cap U.S. stock
-small-cap U.S. stock
-non-U.S. developed-market stock
-real estate
-commodities
-U.S. bonds
-cash
-in equal proportions, rebalanced annually.

and,
"The second part of this analysis compares three allocation models when used in a retirement portfolio — which is very sensitive to timing of returns, particularly large losses. This analysis assumed an initial nest egg balance of $250,000 — quite comfortable back in 1970, although fairly modest now — with an initial withdrawal rate of 5% (or $12,500 in year one) and an annual cost of living adjustment of 3%. Thus, the second-year withdrawal was 3% larger (or $12,875), and so on each year. The superior approach, however — with a median ending balance of over $2.1 million — is the model using seven different asset classes."


For retirees facing the future headwinds of rising rates this study found that:
-during the inflationary periods of the 1970s, the seven-asset model had considerably better performance as a retirement portfolio — finishing with a balance of $2,086,863 for the 1970 to 1994 period, while the 60/40 model ended up at $1,090,081. The pattern recurs in the first four 25-year periods.
-an asset allocation model that has a large commitment to U.S. bonds (such as the classic 60/40 portfolio) may be at risk because if interest rates rise, bond returns will likely be far lower than over the past three decades.
-that a more broadly diversified portfolio is prudent — both in the accumulation years and in the retirement years.
Source:
which-asset-allocation-mix-outperforms?

http://www.sec.gov/Archives/edgar/data/313212/000031321215000150/485a.htm
Launches at the end of August. The manager hasn't really run a fund before, but has been managing some sort of TRP portfolio for the past five years.
Not a terribly informative prospectus, though perhaps an interesting idea. There are four or five open-end funds that bear the "emerging market value" label, mostly so-so or weaker. Andrew Foster made the interesting argument a while ago that value investing mostly didn't work in the emerging markets because there was, in a world of interlocking directorships and chaebols, such a limited prospect for value ever to be unlocked. Andrew suspected that the EM were maturing enough that corporations might feel more inclined to be responsive to shareholders, which might usher in an era of successful EM value investing.
For what interest that holds,
David

Hi BobC,
Thank you so much for responding to MFOer Davidrmoran’s questions with regard to the whys of your near-term cash portfolio asset allocation policy. Your explanations are clearly and understandably presented.
But you did not address the question of why you decided that a 3 to 5-year war-kiddy reserve is the favored approach for most of your customers. How was that reserve time-span determined?
Is it close to the historical average time length of a Bear market? Is it tied to the psychological behavior or biases of your clientele? I appreciate that it is a conservative approach that over the stated 30-year period of your business has been attractive to your customers. Congratulations on preserving their loyalty. It demonstrates that you are doing something right for them.
But that conservative approach is leaving much end wealth on the table. How happy would your clients be if they recognized that their end wealth could have been substantially higher without compromising their portfolio survival odds?
Let’s do a simple illustration over the lifetime of your advisory organization. I’ll use the Portfolio Vizualizer website option titled “Backtest Portfolio”. Since your firm has counseled investors for 30 years, I’ll imagine two starting portfolios in 1984 with one thousand dollars each and not touched through 2014. Portfolio Visualizer will effortlessly calculate the end wealth of each portfolio.
Like in the earlier Monte Carlo simulations, let’s assume a 40/10/30/20 mix of US Equities, International Equities, Bonds, and Cash, respectively as a baseline. That could be representative of a portfolio that your clients might find acceptable based on a 4-year cash reserve recommendation from you.
By way of comparison, let’s switch some of that cash into a Bond holding to reflect a 2-year reserve allocation. In that instance, the mix is 40/10/40/10. Both portfolios are a 50/50 equity/fixed income asset allocation.
What is the end value after 30 years of these two portfolio options?
The end value for the 4-year protective cash option is $12,793. The end value for the 2-year protective cash option is $14,120. That’s for every one thousand dollars invested in 1984. That’s roughly a 14 percent penalty.
The 2-year reserve cash portfolio does marginally increase portfolio volatility from 9.51% to 9.68%. However, during that period, the Worst year was a negative 17.39% and it was registered by the 4-year cash reserve portfolio. Go figure!
That’s a lot of money that you are asking your clients to sacrifice for “perceived” safety. I say “perceived” because the Monte Carlo analyses hint that the 4-year reserves portfolio is slightly more likely for bankruptcy. From an end wealth perspective, the 4-year option is an opportunity cost.
I like Short Term Corporate Bonds as a near-term alternative to cash. Using those to substitute for the 10% cash case generates an end wealth of $15,016 for every one thousands dollars invested in 1984. It does introduce a little more risk.
Let’s test the results for timeframes shorter than 30 years. The number magnitudes and percentages change, but the relative rankings of the three options examined do not change if the investment period is shortened to the recent 20 years nor for the current 10 year period. The 4-year reserve cash option comes at an opportunity cost.
There is a reduced end wealth price to be paid for keeping excess reserves in cash. That’s one reason why active mutual funds maintain a low cash allocation unless some downturn is projected.
I’m sure you access a back-testing tool similar to the one I used at Portfolio Visualizer. I’m equally sure that you generate these type of tradeoff studies for your customers to allow them to make an allocation decision. One size does not fit all clients well, especially given the many factors that influence a final asset allocation decision.
By the way, it took me ten times the effort to report these results than to actually do the calculations.
Best Wishes.

The 3-5 years of expected PORTFOLIO withdrawals protected. The 3-5 year number does not include SS benefits, any pension, annuity income, etc. - just what you would need to take from your investment portfolio. This might include required IRA distributions, cash from taxable accounts, or a combination of these two...whatever you expect to need from your investments to meet your total cash flow needs. So, if you have a $500,000 portfolio, and you expect to need $20,000 per year from this to meet your total needed annual cash flow, we would recommend having at least $60,000 to $100,000 of the portfolio in cash, CDs, or short-term bonds. The strategy helps to reduce the possibility that you would need to sell equities in a down market to generate cash flow. And it still leaves 80% of the portfolio to be diversified. Some clients choose to make the 20% held aside a part of the total (replenish the cash flow bucket as withdrawals are made - maybe semi-annually, but at least annually in up markets. Others prefer to keep the 3-5 year bucket as a separate entity. It has worked for our clients for 30 years. Hope this explains the strategy.

Correct.
A couple of years' cash in addition to SS, maybe a bit more, is what I have been doing in all my calcs.
I was just querying OP about that 3-5y and its source. A good way to stay out of the market unduly.

Perhaps it might be useful to consider the details of the suggestion "to have 3-5 years of portfolio cash flow needs in cash, CDs, or short-term bonds."
I would think that the "3-5 years" figure does not mean that you would need a reserve capable of funding your entire living requirements for that period of time, but merely the "marginal" extra amount over and above predictable income sources such as SS, pension or annuity necessary to fund that period.
1) First, this scenario assumes that there is some annual portfolio drawdown required to maintain the living standard required.
2) That drawdown would be in addition to any income from predictable sources such as SS, pension or annuity.
3) That drawdown may also be reducible if it exceeds the minimum living standard required.
4) So only the amount of cash reserve required to supplement other income sources to maintain the minimum required income level, for "x" number of years without portfolio drawdown, needs be considered, not the entire annual income amount.

That is certainly a much smaller number than the total amount required to maintain the entire required income level, for "x" number of years.
Thanks very much to all who've responded to my request for comments on this particular thread. Quite a nice array of thoughts to consider.
OJ

Hi Davidrmoran,
You raise important questions with regard to a retirement cash cushion requirement. How much is needed? How was that level determined? What fraction of a retirement portfolio should be protection money in the form of near-term cash equivalents?
I retired twenty years ago, and at that time I was exposed to several professional retirement expert estimates. Yesteryears typical number hovered around two years worth of the planned withdrawal rate. Does four years near-term cash provide additional protection benefits?
This is another example of the benefits of Monte Carlo simulations to scope the issues. There is little need to rely on rules-of-thumb or instincts or opinion.
Since the retirement decision is so far in my rearview mirror, I really don’t want to spend too much time doing real work. Therefore, I only did 4 simulations to illustrate the tradeoffs. These took about 5 minutes to complete using the Portfolio Vizualizer Monte Carlo tool. If the subject is of paramount significance for you, a more comprehensive set of calculations is likely warranted.
I assumed a 30 year retirement time horizon with drawdowns at the 4.5% and 5.5% portfolio levels. I used the programs Historical Returns and Historical Inflation options. I postulated a simple portfolio mix with an asset allocation of 40% US equities, 10% International Equities, 30% or 40% Bond, and either 20% or 10% cash. That’s a 4 calculation matrix with a 50/50 split between equities and fixed income sources.
Obviously, end wealth was always higher (like a factor of 2) for the lower 4.5% withdrawal schedule. End wealth was higher for the 2 year cash reserve portfolio. Portfolio survival was marginally higher for the 2 year cash reserve portfolio. At the 2 year cash asset allocation, portfolio survival was 88% for the 4.5% drawdown rate, and dropped to 70% at the higher 5.5% withdrawal rate.
The 2 year cash cushion wins by both end wealth and survival measures.
These sample simulations suggest that you need not concern yourself with a 4 year cash reserve. Although it certainly would increase the comfort zone for any retiree, it is likely an unnecessary luxury. It seems like an arbitrary number. Portfolio asset allocation is always a top-tier investment decision, especially so during retirement.
I suggest you try a few Monte Carlo cases yourself to confirm and expand my brief findings.
Best Wishes.
EDIT: For completeness, here is the Link to the Monte Carlo code that I used in the reported calculations:
https://www.portfoliovisualizer.com/monte-carlo-simulation

Its not a very good article because it fails to site the key fact that might make them attractive though probably not to most people on this site.
If you hold for 20 years you get a 3.5% annual return http://savings-bond-advisor.com/series-ee-interest-rate-rules/

@Scott: Ben Bernanke was the best Federal Reserve Chairman in my lifetime. As showen in the above link duening his tenure the S&P 500, the market's proxy, was up 8 out of nine years for a. 888% batting average. He helped me make a lot of money !
Regards,
Ted

How poignant that some of the funds on this list are having a great year, once again. Retail investors are notoriously fickle. The studies comparing a specific fund's returns, compared to the returns of the average investor IN that fund almost always reflect the hot money trend. Thornburg Intl Value is a perfect example. It is having one of the best years to-date for all international funds.
The list reflects specific share class, I assume, since MALOX, the share class we use of BlackRock Global Allocation, has actually gained assets year to-date. Institutional class shares tend to have less fickle shareholders.
Some on the list deserve the asset losses because of manager changes, culture shift, or extended under-performance due to lax management efforts or allowing assets to grow too much and too quickly.

The current secular bull market has been referred to as the most unloved bull market in history. Maybe so. Oh, for the days of no 24-hour 'news' being blasted at us. Very little of it is news. Most is opinion and hype of the crisis du jour. I suspect that there would be much less angst right now if we were rid of this brainwashing. Are there real worries? Of course there are, but sky-high stock prices are not one of them. That WAS the case in 2000. Sky-high real estate prices and the government's push to allow virtually anyone to have a home loan are not one of them. That WAS the case in 2007. There is very little real speculation right now, and a lot of folks who were invested in 2007 are still sitting on the sidelines, either waiting for the right moment or content to hold cash, CDs, and bonds. The Fed will likely push up the Fed Funds Rate this year, but likely only by 25 bps, then wait to see how the economy and markets handle it. We are not going to see an aggressive Fed in the near term.
A correction is always a possibility in any point in time. That is easy to prepare for, both psychologically and investment-wise. A bear market is another thing, as David pointed out so well. Investors should understand how much their portfolio could lose in a true BEAR market and ask themselves if they can handle that from a life planning, time horizon point. Perhaps the most important thing for folks in the withdrawal stage is to have 3-5 years of portfolio cash flow needs in cash, CDs, or short-term bonds. Once that is done, it is usually easier to handle the downside pressures.
A geopolitical even could change things quickly, so waiting for that to happen is a fool's game. Investors should analyze their portfolio now and make adjustments according to their cash flow needs, real risk tolerance, and investment time horizon. After all, it was Louis Rukeyser, when asked what the markets were going to do, on more than one occasion said "The markets will fluck up and fluck down". So there you go.

"Stock prices have risen rapidly over the past six years or so, but they were also severely depressed during and just after the financial crisis. Arguably, the Fed's actions have not led to permanent increases in stock prices, but instead have returned them to trend. To illustrate: From the end of the 2001 recession (2001:q4) through the pre-crisis business cycle peak (2007:q4), the S&P 500 stock price index grew by about 1.2 percent a quarter. If the index had grown at that same rate from the fourth quarter of 2007 on, it would have averaged about 2123 in the first quarter of this year; its actual value was 2063, a little below that. There are of course many ways to calculate the "normal" level of stock prices, but most would lead to a similar conclusion." - Ben Bernanke

TheShadow is exactly right. This is positioned as a clone of Thornburg Developing World (THDIX), which Mr. Kaufman managed from inception until February of this year. All told, he has about 10 years of E.M. investing experience. He built THDIX into a five-star fund which has roughly tripled the return of its peers since inception and has done so with lower volatility.
In general, Artisan's new funds have performed exceptionally well (the current e.m. product, which wasn't launched in the retail market, is the exception). Artisan professes only ever to hire "category killers," then gives them both great support and great autonomy. That process has worked exceptionally well.
I'm not sure what the strategy capacity here is, but I suspect that bloat and corporate meddling might have contributed to Mr. Kaufman's relocation. The Thornburg fund went from $100 million at the end of year three to $1.2 billion a year later. If my suspicion is true (again, haven't talked with him yet), then it's likely that capacity in the new fund might be closer to $1 billion than to THDIX's current $2+ billion.
It might be that uprooting Mr. K. from Thornburg's rich analyst corps will cause him to wither but the experience of Seafarer and Grandeur Peak give us some reason to be optimistic that the transplant will take.
Regrets for any excess enthusiasm. I might have been overcompensating for the glumness perceived in my June essay.
David

FYI: (This is a follow-up article) (The Linkster has recommended PRHSX over the last several year. Did you follow his recommendation ?) (Up over 33% last five years.)
Investors just lost access to one of the market’s best-performing stockpickers.
Fund company T. Rowe Price (TROW) this week closed its popular Health Sciences Fund (PRHSX) to new investors, a preemptive step taken to prevent the fast-growing fund from becoming unwieldy.
Regards,
Ted
http://blogs.barrons.com/focusonfunds/2015/06/02/t-rowe-closes-health-sciences-mutual-fund-to-new-money/tab/print/
M* PRHSX Performance: http://performance.morningstar.com/fund/performance-return.action?t=PRHSX&region=usa&culture=en_US

David, thank you for your additional comments. I know I don’t know either. I know a lot less than you, which is why I value your monthly commentary. And I often don’t know what I don’t know (2008 proved that a lot of us didn’t have a clue).
A few positive thoughts:
If there is a meltdown in the bond market, your liquidity problem would probably disappear quickly. Low prices bring out buyers. If bonds declined to the point where their payouts equaled say 10%, a lot of that cash sitting in short term treasuries would shift to the long end. There is a lot of wealth in this country that can solve liquidity problems. We saw that during the real estate crash. Pundits thought that the real estate market wouldn’t recover for decades because of all of the unsold inventory, foreclosures, tight credit, etc. But a funny thing happened: thousands of investors started buying those homes with all cash deals. Anyone who tried to buy a foreclosed home on the cheap was confronted with aggressive overbids.
Another worry that we hear often on cable channels is that stocks are going up only because of stock buybacks--financial engineering that is supposedly unhealthy. But the other side of that equation, as you know, is that the corporations that buy their own shares have less shares outstanding, and so we shareholders own a larger percentage of the business. [If they paid out the money in dividends, many shareholders would simply reinvest the dividends, so the result is basically the same.] And many of these companies still have a ton of cash.
Yeah, I’m worried. But then all that worrying seems to feed the next rally.
I have enough cash to pay my expenses for probably ten years. So if I have to suffer through another crash, I’ve got the resources to pay my bills and increase my fund holdings. And I feel fairly comfortable that my conservative funds, many great owl funds, will do a fairly good job of minimizing the fall [though I still remember how a few of my former funds, like Longleaf Partners, failed miserably the last time we went over the edge, and I felt like I wanted to vomit.]

With apologies to OJ, Jerry and the others, Ted was the first to note that David's June Commentary was posted. I'm afraid my initial tongue-in-cheek remark may have been inappropriate or misinterpreted. It was intended to induce others to read this excellent commentary.
I'm a bit surprised at the seeming surprise David's cautionary market outlook seems to have generated. Regular readers of his monthly commentaries know that he has long voiced skepticism (I think well founded) ) about the durability of the bull market and valuations in general. If you also read Ed Studzinski's regular comments, he makes David look like a lotus eating optimist. (As most here know, Ed co-managed the Oakmark Equity and Income Fund for many years, turning out impressive results.)
I don't think MFO participants have been completely "in the dark" on the valuation issue or to the fact that stock markets can and sometimes do drop precipitously (25+% overnight) or flounder for incredibly long periods, as measured in years or decades. That's the risk you take for being in equities. If you read JohnChism's thread about "Bullish or Bearish" you'll find some of the same concerns David has recently raised - though certainly not as thoroughly explored or eloquently stated as only David can do.
To refresh readers' memories, I've clipped a few morsels from some of David's Commentaries dating back to November, 2013. Please read the commentaries in full, as they are easily retrievable on the MFO website. Apologies to David if, in pulling these out of context, I altered the meaning, omitted pertinent context, or changed the emphasis of any. There was no intent to do so.
Regards
-
November 1, 2013: "... a market that tacks on 29% in a year makes it easy to think of investing as fun and funny again. Now if only that popular sentiment could be reconciled with the fact that a bunch of very disciplined, very successful managers are quietly selling down their stocks and building their cash reserves again."
December 1, 2013: "Small investors and great institutions alike are partaking in one of the market’s perennial ceremonies: placing your investments atop an ever-taller pile of dried kindling and split logs. All of the folks who hated stocks when they were cheap are desperate to buy them now that they’re expensive...We have one word for you: Don’t."
January 1, 2014: If you’re looking for a shortcut to finding absolute value investors today, it’s a safe bet you’ll find them atop the “%age portfolio (invested in) cash” list ...They are, in short, the guys you’re now railing against"
February 1, 2014: "It makes you wonder how ready we are for the inevitable sharp correction that many are predicting and few are expecting."
March 1, 2014: "It’s not a question of whether it’s coming. It’s just a question of whether you’ve been preparing intelligently."
April 1, 2014: "Some (money managers) ... are calling the alarm; others stoically endure that leaden feeling in the pit of their stomachs that comes from knowing they’ve seen this show before and it never ends well."
June 1, 2014: ... all of this risk-chasing means that it’s Time to Worry About Stock Market Bubbles."
September 1, 2014: "Somewhere in the background, Putin threatens war, the market threatens a swoon, horrible diseases spread, politicians debate who among them is the most dysfunctional ..."
February 1, 2015: "The good folks at Leuthold foresee a market decline of 30%, likely some time in 2015 or 2016 and likely sooner rather than later. Professor Studzinski suspects that they’re starry-eyed optimists."
April 1, 2015: "(Sooner) ... Or later. That is, the stock market is going to crash. I don’t really know when. Okay, fine: I haven’t got an earthly clue. Then again, neither does anyone else."
May 1, 2015: "For investors too summer holds promise, for days away and for markets unhinged. Perhaps thinking a bit ahead while the hinges remain intact might be a prudent course ..."

Thanks Hank, not because I don't respect him, but I rarely have read any of David's monthly commentaries. So are you saying he is a persistent prophet of pessimism???
I sure would have hated to have missed 2014 as that year pretty much sealed my retirement.

October 19, 1987 and October 2008 did not come out of the blue. The markets were already in established downtrends before that time. David you give far too much credence to "the smartest of the smart money people" In almost fifty years in the game have never found such a creature, except for maybe Uncle Warren. And even he has never had a clue as to market direction. I knew one guy who wrote a book about ........... and suddenly found himself managing tens of millions of dollars. And he was definitely not smart money. It's the dumb money that believes there is smart money out there that knows a thing or two where the markets are headed! Simply look at the so-called "smart" money hedge fund managers and their performance since 2008. Personally I would love to see the persistent prophets of pessimism get it right now. The best money is always made coming out of bear markets. Another nasty bear would thrill me no end.

Hi Old Joe,
For ease of scoring your survey, I’ll give a single word answer, and I’ll explain later: Nothing. I plan no immediate action.
My “just stand there, do nothing” approach is grounded in several dimensions.
For decades, both studies and practical experience have demonstrated that “Forecasters can’t forecast”. The marketplace should be tightly coupled to the economy. Yet even eminent economists constantly can’t get it right. In late 1929, Irving Fischer predicted that stocks had reached a high “permanent plateau”. He, along with John Maynard Keynes, lost a fortune in the marketplace. Fischer was destroyed, Keynes recovered later. Economist’s dismal forecasting record matches ours. It’s not pretty.
As Keynes remarked: “Investing is an activity of forecasting the yield over the life of the asset; speculation is the activity of forecasting the psychology of the market”. These are both error prone assignments. T. Rowe Price noted that “No one can see ahead three years, let alone five or ten”. I pass on the forecasting job.
Our esteemed MFO principals did not really make a forecast. A proper forecast requires a defined timescale and a magnitude estimate. Our team leaders merely hinted that the warning flags are flying high. Given the length of the current Bull market these flags have been raised for a long time now. As cycle time increases and as prices escalate, downturn risk must also increase.
I have no idea if we are in ninth inning of the present Bull or in the seventh inning. But I suspect we are somewhere in the late innings. That’s merely my opinion, and surely not a fact. The fact that institutional professionals are heavily on the side of at least a short-term continuation of the Bull market is somewhat worrisome.
Lastly, I am a very senior long-term investor. I react slowly and in incremental steps. Before the release of the MFO June report, I planned to not make a portfolio adjustment until mid-December. Both my wife and I will execute our Required Minimum Distributions at that time. The June Commentary did not inspire me to alter that plan. Certainly other exogenous events could do so. Mostly because of age, our plan is to reduce equity positions in favor of more income secure holdings. That’s obviously not for everyone.
Old Joe, your post has successfully solicited superior replies. Thank you, and thank everyone for their excellent participation.
Best Wishes.

Hmmm ... I blew a job interview once with a particularly weak answer to the request to "describe a hard decision you've made and how you went about making it." I'd spent much of my professional life making really consequential decisions about people's careers, the direction of my college and so on. After a while, it struck me that I was tripped up by the word "hard." In my mind, "hard" decisions are consequential decisions you're forced to make without having enough understanding to make them well. Because I tend to obsess about advance planning, very few of my decisions felt hard though many of them were profoundly painful.
That's where I am now on the market. I'm not particularly concerned with corrections or bears because, though I can't predict them, I understand them and can plan around them: Adjust your savings and withdrawal rates, shift asset allocations at least at the margin, ignore your portfolio whenever you feel the urge to do something brilliant, and be very comfortable with your managers. Meh, no biggie.
The thing that has me worried is the argument that I've heard now from several managers that the system itself might be broken. That's manifested in the liquidity arguments that I've been writing about. "Highly liquid" assets are, by definition, easily valued and easily traded; Treasuries are the paradigm case. We buy investments with the assumption that we can also sell them. Those sales happen through the good offices of intermediaries, sometimes called "market makers." Those folks maintain pools of tens, perhaps hundreds, of billions of capital. They buy your shares, using their money, at a fraction of a penny per share below the last price. Sometime later, maybe minutes, maybe hours, they sell it someone else for a fraction of a penny markup.
So, three parties to the trade: seller, market maker, buyer. We traditionally worry that high valuations will eventually make buyers scarce. That is, no "greater fool" is available and you have to sell your holdings at a discount. Buyer/seller mismatch. "Correction" occurs.
But what happens if the problem isn't between buyer and seller but between seller and market maker? That is, what if the conveyor belt that normally, quietly, profitably, invisibly moves shares between sellers and buyers isn't working? I'd like to sell $100 million in a bond and you'd like to buy them for $95 million but there's nobody capable of coming up with the initial capital to move them from me to you? At base, my bond would become unsellable, illiquid. That's the liquidity crunch.
Why might that occur? There have been a bunch of shifts in the financial services industry, some occasioned by good-spirited reforms imposed after the last two crises (two of the three worst market crises in a century occurred within eight years of one another, wonder if that's significant?), which have fundamentally impaired the number and size of intermediaries.
David Sherman and others have pointed out that that's already happening in some corners of the market: people are finding it almost impossible to sell very large blocks of bonds, people are finding it hard to sell stocks at mid-day and so on. And that's occurring in the good times. What happens if large, highly-leverage investors get spooked and try to unwind, say, a half trillion at the same time and find that they simply can't? Do you get an October '87 repricing (down 23% in an afternoon)? Do you get a fundamental change in the willingness of international capital to underwrite us because we're no longer "safe"? Do you get an October '08 freeze (where even the shortest term, most liquid paper couldn't be traded and volumes dropped 75%)? Do you get employers who can't honor their payroll obligations because they can't tap the paper markets? How might you react if your employer that they were hoping to be able to pay you sometime in the next week or so, at least part of your normal pay, but they weren't able to give a time or amount?
And is the fact that the smartest of the smart money people - that top 1% of institutional and private investors - are worrying about their own ability to "get out the door" independently significant? When guys who manage money for the really rich tell me that they're "standing outside the theater, shouting 'fire,' but nobody's listening," should I write them off as simply alarmist?
Here's what I got for answers: dunno, dunno, dunno, dunno, dunno, dunno, dunno and dunno.
Which I really dislike.
So, yeah, I think the markets are pricey but that's not really the thing that's nibbling the most at my brain.
For what that's worth,
David