I’m BAACK!!!

DIS and DAT - I’m BAACK!!!

A few years ago, I wrote; that I thought I covered our thoughts on investing in these periodic communications. We decided to begin sending a “Market Analysis” type of report. Reggie does a great job compiling and then sharing this report every quarter, helping us to reset our value markers.  The difficulty arises in keeping our clients up to date, while still avoiding the damages of short term thinking and kneejerk, emotional reactions. In my periodic contribution, I hope to refocus on the question “Should I REACT to those headlines?” One of those core principles, that are important to discuss, is that we believe market price can differ from reasonable valuations due to emotional action of market participants.  

Our aim is to continue with the “Analysis” that Reggie does and I add my wonky, philosophical bend in pieces such as this titled, “Dis and Dat.”  Since moving to our website, we have not added them, but we do plan to in the future so we can link to older editions.

               We found that when we don’t review philosophical investment concepts at all, silliness sneaks into the investment thoughts.  It seems the “Pied Pipers of finance” plays a slightly different tune, but all the same results from following him ensue.  Due to group think and the tendency to act like lemmings following each other over the cliff, prices diverge even more from underlying value as the crowd grows behind. 

                Let’s tackle the three popular investment items that are currently driving me bonkers.

 

1. Incomplete mass investment advice of “Just Index”
2. 60/40 Cure All
3. Digital Riches for All

“Just Index”?

 

“Everything popular is wrong”  Oscar Wilde

 

                In his 2014 annual letter, giving some allocation guidance, Warren Buffett backed the idea that the average investor should buy a broadly diversified U.S.- based low cost index fund.  I suppose, to the average person, that Warren Buffett giving investment advice was nothing new, but this is different.  Previously his advice has been philosophical, instead of specific. A philosophical investment thought can never become overpriced due to its popularity, however a specific recommendation can. You see the media and others have now “popularized” his specific advice, which will make it less beneficial and more potentially harmful. 

               Similar to Oscar Wilde, Warren has said philosophically that a wise investor should “Be fearful when others are greedy and greedy when others are fearful.”   What, then, is one to do when buying a broadly diversified U.S. -based low-cost stock index fund has become popular and, dare I say, “greedy”?  Our advice is to err on the side of his philosophical advice and not his specific advice. BE FEARFUL.

 

               What is there to be fearful of in buying a popular broad based low- cost U.S. index fund?

I will give you seven reasons for pause…

1. The underlying assets have become relatively over- valued? As an example, our internal contrarian model currently favors international index over domestic. At its core, the model is a simple buy low/ sell high tracker.  Buy low/ sell high is usually quoted as a good strategy-except for now. We all know this, but following it is a different matter.
2. The underlying assets have become priced for perfection (no margin of error/safety).  See next section on digital stock riches. As Yogi would say,“ It’s Deja vue all over again.”
3. The allocation doesn’t match your specific situation. The general index tools they speak of are 100% stock based. (Is it any surprise they are popular now?)
4. The strategy and philosophy doesn’t work for you.  The strategy is to hold even through 40% drops in pure panics, a.k.a. the financial crisis. If you have proven the ability to do this in the past, kudos to you. What about going up to ridiculous heights in order to receive the index fund returns you had to hold during the early 2000’s and the run up of the late 90’s.
5. Historical returns do not match future returns. Can the U.S. repeat its birth? By now we have all heard you can’t rely on past performance to predict future results; yet a lot of the reasoning to buy an index tool is based on historical performance.
6. The person that you took your advice from dies, or changes his or her mind without informing you.  As much as we would all love a “set it and forget it” tool for finances, one has yet to materialize.
7. The next market move may be different from the recent past. The early 2000’s saw tech crash, then 2008 saw a finance crash, and 2014 saw an oil crash.  Will the next crash be those again?  Will it be bonds?  Will it be a spike up in prices?

 

Why not 60/40?

 

                We often run into questions either from those within the industry or clients and potential clients around the above question. Here is our take.

               First, a definition.  Over the years, the phrase has become a symbol for a middle of the road approach to allocating one’s capital.   This typically means a broad allocation of 60% stocks/ 40% bonds. I will just stick to the two major problems we have with using the theory for a basis for capital allocation: 1). the devil is in the details, and 2). it’s based on past price performance.

 

                As to the first problem, even with the invention of index funds, a human being cannot possibly hold two positions for their entire life in exact equal amounts.  A 10% move up on stocks…. whadd ya do?  So, the “concept” is incomplete on the reality needed to deal with life’s investment problems.  The next place where we come to an incomplete solution is when a person ages. The fact is that a human being, after having saved up his life savings, is likely to begin withdrawals. The distribution phase of life is different than the accumulation phase. So how does one solve the distribution problem?  More questions arise:- Does a preferred stock go into the bond or stock category; does a high yield bond go into a bond or stock category?  Your choices on just those two will shape the future return differently than the mythical historical return of a “60/40” portfolio.

 

                So, what is lacking in solving this first problem?  It is our belief that the “lack” is ongoing personal management.  We believe that no matter what tool is invented, that your money will need management by someone and the value of that management will be based on the value of their reasoning.

 

                Now I will give you my attempt at describing the second problem.  When we reflect to 1982 or so, an investor would find a much different investment environment.  The interest rates were high (very high- for those born after 1990, you won’t believe them) and falling.  High interest rates meant you could buy bonds and sit there collecting a very nice, say, 15% annual interest payment.  The previous period’s high interest rates and inflation also caused stocks to have a previously horrible period and were priced to yield a great amount of earnings.  But don’t forget the “and falling” part- that’s the clincher.  The “and falling” meant that both prices of bonds and stocks did exceptionally well for a very long time.  So if we are at 0% recent rates (negative for German bonds) and rising, do you think you will get the same results?  Those results are what most people are using to provide their “advice” to you.

 

In conclusion people advising a 60/40 allocation are not advising based on your risk tolerance, withdrawal needs, or valuation.  Instead, they are choosing an allocation based on what worked from 1982 up to a few years ago. We call that type of decision making time- period- based advice.  We would rather use personal and fundamental needs -based allocation. Most robots have no choice but to use the former.  Luckily, human advisors have a choice, though most unfortunately choose the former. 

 

Digital riches for all?

This time it’s different, again?   The acronym FANG is currently used to describe the craze.  FANG is the first letters of the stock symbols of the current market darlings.  The last acronym I recall was BRIC- Brazil, Russia, India and China.  They were taking over the world… but I digress.  The similarities building between the digital stocks and the late 90s, or the nifty fifty- mid 70’s are eerie.  No one knows when it ends, but it shouldn’t be long at this rate, and the world will be theirs… eee HA HA..(that’s my evil laugh impersonation).

 

 

Just for reference I jot down these numbers on 7/18/2017 from yahoo finance:

FaceBook market cap of 472 Billion

Amazon market cap of 490 Billion

Netflix market cap of 79 billion

Google market cap of 674 Billion

Bit coin market cap of 38 Billion

Market cap is defined as the total dollar market value of a company’s outstading shares by investopedia.

 

               To sum up, choosing your investments should be about what will work best for your funds and your life.  Choosing the popular path may feel comfortable and may even work for a time. We believe evaluating your circumstances and investment value will be a better path to travel, even if it is less worn.

See you next time.

James Pope

 

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