Monday mashup – what to say?
I was of course tempted to put Christmas greeting is the heading and I do of course hope all my readers will have a healthy, peaceful and reflective break.
However, most of you will like me have families and would have been looking forward to seeing children, nieces and nephews, grand children and other family members, and that may not be possible now. The international news this morning is especially gloomy about the Covid-19 situation in the UK with some news media extracting (arguably out of context) the health minister’s phrasing that the situation is ‘out of control’.
Actually Covid infection rates are much worse where I live and the situation is being controlled (hopefully – not much evidence so far) by really tight quarantine measures. They may have been left to the last minute in the UK, but my guess is that the stricter measures are the right action and will need to last a while. At least vaccination programmes are getting under way
In terms of prospects for economies and the long term future of certain types of business, we have serious cause for concern. That is compounded by the approach of January 1st because whatever terms the UK will be applying to trade and other forms of necessary collaboration with mainland Europe after that, there will be more friction.
The processes of trade are used to spinning at high speed, like a well oiled machine that never switches off. Any engineer will tell you that even a small increase in friction, or a loss of lubricants, will cause overheating, unpredictable performance and even breakdown of sophisticated machinery.
But, as we know, investment markets and the economy are only connected in a complex and indirect manner, like the weather and the price of your morning coffee.
There are plenty of purely financial reasons for betting on stock markets continuing to rise – accommodative central banks, the rise of SPACs, digital money trends and much more. This I will address in more detail in my comments next month.
So, what to expect? The Spanish Inquisition? But nobody expects the Spanish Inquisition :-). (non-Monty Python fans please indulge my whim!).
My point is that markets are overvalued in many sectors and regions by a large margin on conventional measures, but nonetheless one can still make money riding the momentum.
Such unusual times require a thoughtful and intelligent approach to investing. I hope that in 2021 I can help you follow such a course!
A recommendation – this year’s BBC Reith Lectures
I an grateful to one of my subscribers for letting me know that this years lecture series is currently being delivered by Dr Mark Carney, formerly Governor of the Bank of England. His theme is ‘How We Get What We Value’.
The first 2 have been fascinating and take a line that somewhat surprised me – addressing the need for capitalism to reconnect with society and morality.
I listen on BBC Sounds , but I think this link will get anyone to the right place –
Monday mashup – ‘It’s the economy, stupid’ – except it isn’t
Economics – the art of educated guesses
The quote in the heading is a well known slogan from Bill Clinton’s campaign strategist James Carville, with the addition of the word ‘it’s’ to what he actually wrote as one of 3 key messages on an office door sign for fellow campaign workers.
I usually recall this quote when reading or hearing economists expounding on the prospects for financial markets by sourcing data and theory from their world. I am a general sceptic of economists, loving the quotation that ‘economists are people who will tell you tomorrow why what they predicted yesterday did NOT happen today’!
I studied some basic economics in my youth and whilst micro economics is a good way of explain aspects to human behaviour, macro economics is more like weather forecasting: immense computer resources are devoted to predicting what will happen in the future, and then a butterfly flaps its wings somewhere in Latin America and it all turns out to be wrong (a premise put forward in an explanation of chaos maths which I once read).
Even ignoring my economist-ism, it is widely understood and very easy to prove that in the near term, investment markets do not in any consistent way perform in line with economies. In some ways, equity and bond markets act as predictors – for example, adjusting in anticipation of prosperous times. At other times, they anticipate recessions, but more often than not a recession has to be proved to be both set in and long term before a raging bull market will correct.
At this very moment, we have august bodies of economists predicting recessions of catastrophic proportions in many global economies, central bankers looking into very empty tool bags and yet many stock markets are at records highs
So is economics useful to investors?
Yes – but not as a basis for deciding what to buy and sell in the short term. We have to remember that the main driver of market prices is supply and demand (some micro economics there) with a good mixing in of human behavioural biases.
Some times and to a greater or lesser extent, macro economic trends that are well set in (like anti-cyclones with the weather) will have an obvious impact on the profitability of companies. If investors can see a major change (eg the reaction to global warming) as being certain to change the way some things will be done (in this case, the slow demise of petrol and diesel cars), they will make investment decisions to try and own shares in those businesses that will profit from such a change.
Note that they will often be wrong, as investors in Clive Sinclair’s C5 must recall, even though he was exactly right in seeing a future for vehicles driven by a big electric motor.
My observation is that the decisions to follow economic trends are driven not by dry data or economists’ modelling, but by an understanding of a well developed story that every one knows. Investors, even the most specialist and experienced are only ordinary human beings like we are and it is a sure thing they have no better knowledge of the future than we do. I appreciate that is a generalisation and some of us, and some specialists, will be a bit more insightful than others.
Big fund managers do employ strategists (a sort of specialist economist). That is like the rulers of old employing soothsayers and magicians. Today they may use computers as opposed to examining the entrails of a sacrificial goat, but I doubt that their success in making predictions is any better.
Economists as social scientists do help us understand how the world works to distribute money and resources and we benefit from that understanding when applying different techniques, mostly to do with the concept of value and risk, when selecting our investments.
Finally, it is only fair to say that some people we know to have been influential economists were, after some practice, great investors – most famously John Maynard Keynes. But some footballers are great golfers, so one has to be careful not to assume a correlation!
Advice from the professionals
CFA UK is the professional body for investment managers – your scribe was awarded one of its qualifications in his younger life. It recently expressed some concerns about the impact on portfolio diversification of a long period of negative interest rates. It suggested advisers might want to look through the following checklist. If we take out the references to clients, it would be a good one for do-it-yourself investors to work through on their own account.
Are my client’s return expectations reasonable given the low expected future returns offered on many assets?
In light of the above, are my client’s current contributions (or savings) sufficient to meet their objectives?
Conversely, are some clients assuming too much risk in order to hunt for yield in a low return world? For example, are risks now higher than they were for traditional portfolios with high government bond weightings (my emphasis)?
When considering risk, what are the limitations of my risk model(s) in relation to the assets in which the portfolio is invested? Do they, for example, rely completely on historic correlation, volatility and drawdown data which may not hold in the future? How have I addressed those limitations, even if only qualitatively?
How long would it take to liquidate the client’s entire portfolio? How much would it cost do so? How do those figures compare with the past and is the level of exposure to illiquid assets still appropriate for the client’s needs?
As the hunt for yield continues, are my client advice and investment decisions accounting equally as much for the risk characteristics of a product/asset as its return potential?
I think the third paragraph is particularly relevant to those investors with passive multi-asset portfolios that are biased to fixed income stocks, like a Vanguard Lifestrategy 20% or 40% equity fund. The conventional risk control offered by owning long dated government bonds may well not hold good in the next few years
‘This is insanity!’
I quote from a US venture capital specialist whose words I read this morning, commenting on the stampede of investment funds into new businesses, the vast majority of which are not making profits and in some cases not even making products!
His main reason for making the exclamation is that new ventures are able to secure new capital funding, on notionally higher equity valuations, as often as every 6 months. That used to be something that happened every 2 or 3 years. It is said that there is so much money available to invest that investors are actually queueing up.
That can hardly encourage the target companies to use the cash prudently – there are now anecdotes of fantasy order books and family members getting huge salaries to do nothing obviously useful.
A more sober fact came my way last week. Premier Miton presented data giving the CAPE (cyclically adjusted price earnings ratio) ranges for global markets as measured by the MCSI World index for various past time periods.
Naturally this ratio is highest when markets are expensive and has been highest of all ahead of major market setbacks, like in 1999/2000. The current data point is right at the extreme of the range, just where it usually is ahead of a sudden return to reality.
Of course, no-one can say when a crash will happen and it usually happens so fast that one knows about it too late to protect ones profits.
As I have written consistently, timing markets is very difficult and the battle with human psychological biases is tricky. Crashes are always reversed over time anyway. So staying in the market is logical and in the long run gets rewarded.
However, I do think it might be wise to note the frequency of warnings from objective commentators that the runaway train might be about to come off the rails.
I am taking profits from my best performing holdings constantly now and only buying anything new that is great value, has not made much money for ages and comprises companies with cash flows generated by actually delivering goods and services at a steady profit.
And I am still retaining plenty of cash – I would much rather miss out on some of the ‘opportunities’ that are soaking up the tsunami of cash let loose by central banks.
As a lesson, I have excellent memories of people buying over-priced spec built houses in the early 1980s with 100% mortgages – the mass of repossessions that followed the collapse of the boom cycle was such that individuals who had cash on hand were able to buy multiple properties at knock down auction prices (at times 60% below the original purchase price) and they then set up property rental portfolios that made them millionaires in a decade or so.
As someone famous (probably Mr Buffett) said, the foremost mantra of investing successfully is ‘buy low, sell high’. I am attempting a bit of both. I still have a core portfolio in the markets, of course, but as I have said before, tinkering at the edges can be profitable. That means being active, taking profits often and if those profits are to be re-invested, buying with utmost care.