Q3 2014 has granted investors another positive quarter as summed up by the Wall Street Journal:
“Dow up 1.3% and the S&P 500 up 0.6% in the third quarter. The S&P’s quarterly gain marked its seventh in a row, the longest period of gains since a 14-quarter winning streak that ended in 1998. The Nasdaq also posted its seventh straight quarterly gain, its longest streak of wins since the eight quarters ended in 1996. Evidence of an improving economy—second-quarter U.S. growth was revised higher to 4.6%—and the Federal Reserve’s accommodative monetary policy have helped boost the allure of stocks.”
http://online.wsj.com/articles/u-s-stock-futures-advance-1412079824
See http://www.bloomberg.com/markets/stocks/ for complete coverage
The Fine Art of Doing Nothing
Napoleon said that a military genius is “The man who can do the average thing when all those around him are going crazy.”
That genius may be nurtured for investors by taking the time periodically to rehearse and meditate as to how we need to behave during negative and volatile markets. Downturns are not uncommon. The precise frequency and magnitude of down markets is a complex and often random path that is completely counter to the way our brains have been trained by the daily and seasonal cycles of life. Market moods change quickly and it is impossible to predict their short term direction.
The modern experience of the workweek, school year, cell phone contract, car loan, 2.5 children (haha) and monthly bills are but just a few of the cyclical patterns that we are conditioned by. Markets are not much interested in what your “Plan” is. The market cycle is driven by productivity growth, demographics, technological developments and other complex trends that all come together to create the economic reality that we experience.
Plugging into the trends that exist and profiting from them is the $64 billon dollar dilemma. It is a whole lot more complex than a horse race. Might it be that we need to avoid trying to see what is coming and focus on staying strong and patient in the face of whatever the market brings? Attempts to create prediction models of future economic and business trends may very well be futile. That does not mean that people will give up trying. It is easy to think of examples of “races” that produced quite unexpected outcomes. A marquee example of recent times is Facebook. There were many companies attempting to capitalize on the concept of the social network long before Zuckerberg was admitted to Harvard.
Were the executives, management and employees at America Online and My Space simply not as smart or determined? Maybe. The crucial differences may have been quite nuanced or even random. For example, Facebook took root with targeted groups of college students as primary users. This may have allowed the rapid growth in a Facebook user base that has spread geometrically into a global juggernaut of the ages. Now AOL and My Space are former giants with little more than ghost towns where the former virtual communities once existed. It is something that was extremely difficult to predict as it happened.
In hindsight, investors will remember what a genius Zuckerberg was and how all the others missed the opportunity of a business lifetime. The reality is that there were many moments along the way where the investment potential of social media was very much in doubt. One needs to look no further than the News Corp purchase of Myspace in 2005 for $580 million and subsequent sale in 2011 for $35 million. Basically a total loss for News Corp in an area of business that has become a hotbed of investment and innovation among social media upstarts like LinkedIn and Twitter.
Numerous examples of this dynamic of miscalculation in real time are easy to find. The New York Times http://www.nytimes.com/2014/09/30/business/energy-environment/a-u-turn-for-a-terminal-built-in-texas-to-import-natural-gas.html?ref=business
provides an insight on a $2B investment by a trio made up of Exxon, Conoco and the oil kingdom of Qatar to import natural gas to the United States. The project is known as the Sabine Pass Liquefaction, LLC. Liquefied Natural Gas was seen as a great opportunity to transport natural gas that had historically been only distributed regionally via pipelines. The business world had always feared that the USA would demand an ever increasing amount of energy that could never be satisfied by domestic production. It turns out that the United States created an historic glut of natural gas domestically through drilling technology and innovation. The domestic production in the USA rendered the import terminal project uneconomic and nearly useless. The $2B import terminal has never delivered a drop of gas.
The Sabine Pass Terminal story is a stark illustration of how some of the most able and experienced operators in the energy business cannot predict markets of the future. How the $2B could be invested into a massive loss by players so deeply immersed in the natural gas business? The takeaway here should also emphasize that this is the price of innovation and that there is high risk in investing with anticipation of future demand.
Efforts to make predictions are of course necessary for individuals to make plans and decide in what areas to invest in and pursue. Holders of diversified portfolios can avoid trying to pick the winners and patiently wait for the future to reveal itself. Diversification is far from perfect and cannot prevent the cost of failure, ineptitude and miscalculation, it can only reduce its cost.
In our patient posture we will also be faced with endless scenarios of failure and decline. The storyline of destruction of what we have now is always lurking and often creates anxiety and urge for safety. The human mind is perpetually worried about what we will lose. That is what has allowed us to survive. The Loss Aversion of human nature is a useful and positive evolved trait that inspires us to work hard and innovate. This fear of running out of supply is what creates the hard work and efforts of countless businesses in the creation of the bountiful inventory of consumer goods that are available at Target Stores, Apple and Whole Foods Market et al. But this fear can draw investors down the seductive path of handicapping the trends. It creates the desire for estimation and prediction of the future.
The goal of picking winners and navigating among the complex trends is highly improbable. It is also quite interesting to see detailed study that may show that rebalancing and allocating investments based on performance data may actually reduce results. See Financial Analysts Journal
http://www.cfapubs.org/doi/pdf/10.2469/faj.v65.n6.4
for some complex and interesting material on this subject. As the study notes,” it may be indicated that Portfolios of products to which they allocate money underperform compared with the products from which assets are withdrawn.” Simply stated, what you sell may do better than what you do with the proceeds.
In a basic and more anecdotal view, it seems that we need to hold our portfolio positions we take over long periods, unless there are compelling reasons to change, such as a loss of confidence in a particular fund, change of manager, or serious divergence of performance relative to peer group. Warren Buffet spoke of this issue way back in 1990 http://www.berkshirehathaway.com/letters/1990.html
Warren Buffet said “inactivity strikes us as intelligent behavior” and “Lethargy bordering on sloth remains the cornerstone of our investment style.” It seems that “Lethargy” and a stubborn slowness to react to current opportunities or threats is a trait that we need to seriously consider as investors. Discipline and patience are the key dynamics that create our future strength and success as investors. It may be that Buffet wanted to characterize passive traits a little more dramatically to get his point across, thus his use of “sloth” and “lethargy” to emphasize the point.
Simplifying this concept into a strategy of making as few decisions as possible may be worth consideration. Investors may need to think more like swimmers and less like baseball players. As the swimmer works patiently toward the smooth stokes of the speed and distance goal, a calm peace and Zen-like state of mind would be optimal. The baseball player is constantly adjusting and thinking about the next move or pitch , and where the ball is going is extremely difficult to predict. The ultimate goal should be a high quality, broadly diversified portfolio that can be held onto with confidence through all the twists and turns that the market waters will flow towards us on a daily basis.
A key driver of recent macro-economic conditions has been the Federal Reserve’s policy of Quantitative Easing of the money supply. http://www.economist.com/blogs/economist-explains/2014/01/economist-explains-7
It may be argued that this money printing policy developed during the deepest stage of the financial crisis will prove to have complex and long lasting impact that is very difficult to anticipate. Massive additions to the global money supply may take many years to actually be absorbed into the financial system and global economy overall. The consequences of effective devaluation may only be beginning to be felt.
Our central bank has implemented a process this year to slow or “Taper” the process of money creation to an endpoint and then ultimately return interest rates to some level closer to historical averages. The path of removing measures that were taken during the Financial Crisis will likely be very challenging.
A recent Barron’s cover story http://online.barrons.com/news/articles/SB52133021052493823286804580156343204675582
provides some interesting thoughts on how Americans have been conditioned to be anxious about the amount of money they are saving for retirement. Here is a passage from the piece that I find particularly important:
A Pew Charitable Trusts study last year, meanwhile, concluded that Gen X workers are in worse shape than baby boomers — but that venerated institution based its findings on the assumption that these younger workers would not save anything more over the next 20 or so years they have before retiring. “The reports have concluded we are on the road to retirement perdition,” says Sylvester Schieber, a veteran pension and Social Security expert who analyzed recent studies, their sponsors, and assumptions. Schieber has come to a less dire conclusion, in part, he says, because he has no masters to please. “If you are an oracle to a certain group that likes to hear a certain story, you tell it, and it becomes documentation,” he says.
I have been witness to significant use of scare tactics and fear mongering by the financial industry in effort to convince individuals that they need to save at extremely high rates to be secure in the future. The right amount of saving and spending generally needs to evolve slowly and if an individual or family tries to save too much, it will generally cause stress and turn counter-productive.
It has always been apparent to me that the balance we must strike between what we save and spend is quite delicate. The give-and-take between today and the future is an endless battle that is unique to every person and family unit. As many of you know, it is my view that we need to see the long game year after year and to strive for a full embrace of our daily lives and the future potential of our financial strength. There is no clear formula and much of the data is irrelevant to a particular individual. Each of us needs to be in tune with what is really important as we live through our days. Gradually seeking to save more and believe more strongly in our investments while enjoying every minute of our collective journey. That is the state we need to aspire to.