Markets

Monday mashup – ‘It’s the economy, stupid’ – except it isn’t

14th December 2020 by Mark Potter Leave a Comment

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 have seen more wrong economic predictions than bad weather forecasts.

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!

Monday mashup – the hokey-cokey

23rd November 2020 by Mark Potter Leave a Comment

The title reference is to the ‘in, out, in, out shake it all about’ line in that dance. I am prompted to write about the evergreen conundrum of market timing, mainly as a refresher, for two reasons.

A perpetual question

Firstly, when I am completing the first stage of my training plans with subscribers, they inevitably become nervous when the time comes to actually make purchases from cash reserves. Secondly, the current climate is one where all 3 of the major uncertainties overhanging financial markets for so long are becoming less unpredictable (US elections, Brexit and Covid-19). One might say, one sorted, one soon to be sorted in a way we can predict and the last looking a bit less disastrous.

The second factor suggest it might be a good time to invest but unusually the pricing of large parts of the market suggest there are only 2 games in town: booming new tech growth stocks and dull low value businesses doing old fashioned things. This makes decisions on purchasing far from straightforward without some discipline and methodology.

Resources

I have written on this subject from various viewpoints before. Here are some reference points (several will be subscriber only):

How to time investment sales

Blog post -June 2018

How to pick a fund for the future or how to be a contrarian

A fable for investors

The last article is quite long and I enjoyed writing it, but it may be tricky to follow for some readers. It serves to show that decisions to take money out of markets and re-invest later can be rewarded handsomely but in most cases, the source of the extra profit is luck.

This article can be understood well enough if you skip past my ‘in’ jokes about the financial system in the back story and start reading from the ‘3 decisions’ paragraph.

Some basic common sense

There is good sense in buying obviously cheap markets after a crash and not piling all your free cash into a market that has been booming for years. But aside from those common sense observations, I would suggest the best approach is to think about the long term and have a simple risk minimisation strategy.

Some years ago the then famous fund manager Anthony Bolton (a contrarian manager by style) used to often say that ‘time IN the markets is better than TIMING the markets’. If you look at very long term graphs of stock markets you will see that he is absolutely correct. The line goes steadily up and unless you have a gigantic screen or very large piece of paper, the compression of short term movements means you will not be able to even see the large drop of say October 1987.

Don’t focus on the wrong data – investment is long term

Two things need to always be born in mind:

Every investor, however skilled or experienced buys the right investment at the wrong price when judged over a week or a month, but that might look like a stunning piece of judgement over 5 years or 10 years. In fact, I personally often buy investments I expect to do well a little early and lose money until the market catches up with my analysis. I don’t mind an initial 15% loss if my investment is up 25% in a year’s time – I might have made a lot less if I had waited and the price had already gone up 20% from the low point.

So rule number one it to not get all bitter and regretful about a fall in price in the early weeks or months of a well thought through fund selection.

The second idea to always remember is that when you invest sensibly (ie in diversified and intelligently chosen blocks of shares), you are just jumping on the capitalist machine. It’s function is to make money for investors and over time IT ALWAYS DOES.

Some of us (me included) find the way in which that happens at times rather inconsistent with our personal ethics, but that is really rather irrelevant – the machine exists as a part of the world and without it, the world would not function – even the Chinese communists seem to accept that.

So even if the machine grinds to a halt due to a malfunction from time to time and some people lose faith in it, it gets fixed pretty quickly. One only loses money from a diversified portfolio of collective funds (irrespective of when you bought an investment), if one withdraws money at the wrong time.

So the thing to worry about is managing your cash flow, not when to invest.

If I could ever claim to have been a good IFA, I would like to think it is because I got people to think about objectives first and short term investment returns second. If you have 3 young kids and can only afford one family car, you don’t start your selection process with 0-60 times and top speeds.

We all keep learning

To improve returns, it may arguably make sense to phase investments of larger sums – I accept that. Refer to the various articles listed above for other angles, but don’t expect a neat ‘this is the trick’ answer – it does not exist!

But we can try different techniques and become a little more skilled. We will make mistakes on the way – the world can mess up the most rational decisions. In investment portfolio construction and purchase, the only perfect science is hindsight

Monday mashup – crystal ball gazing? Or forecasting?

28th September 2020 by Mark Potter Leave a Comment

It is easy enough to work out what investors have to worry about at the moment and to give those risks a rating on probability of causing problems – even to guess when the problems will emerge. For example:

The US elections – happening very soon and a risk if there is not a clear win for Trump or Biden and Trump refuses to depart even though the polls say he has lost. I don’t think which candidate wins will make much difference on its own to US stock markets, but a constitutional crisis would.
Covid 19 – a risk that stock markets are in effect ignoring because many players like the consequent pouring out of nearly free money that is either in effect being invented, or which will be a burden on future tax-payers (which won’t include them, of course!). This Nelson like way of viewing global economics will maybe win a battle, but like Nelson, the corporate warriors won’t be able to avoid a bullet for ever. When it will come is unclear, but I suggest this is a medium term risk.
Related to the above is over valuation of shares – the detachment of many companies’ valuations from a logical base and therefore the undermining of many established rules for making sound investments. This looks to me like a repeat of various past periods in recent history. Such bubbles of investment naivety usually burst without much warning. That could be any time soon.
And finally for Brits only (and maybe with lesser consequences for Europe) – Brexit. This one has a very easy to observe time scale. We will probably know in less than a month whether or not a deal is really going to happen and even if that is strung out as some suspect. we are going to know by Christmas. The emails I have been getting from the Foreign Office as an EU resident Brit suggest that a least that bit of government is certainly expecting no deal.

None of the above will be new to readers, I am sure, but I find it helps to keep the simple facts in mind when fighting one’s sub-coscious biases, like the Fear of Missing Out (FOMO).

When it stops raining, the sun will come out!

Of course, there are always risks, including ‘Black Swan’ events that might dent our invested wealth and blow our plans off course.

What perhaps is unusual at this time is that it is so easy to see so many risks and know that the market is not properly ‘discounting” them (ie allowing for them in valuations), except perhaps the last one, Brexit.

With the exception of some international mega cap businesses and selected mid and small cap firms, the UK stock market has performed very poorly for some time now. The relative performance of the main UK indices has been awful.

Because the Brexit risk is rapidly coming to a head, one might take the view that whatever happens, the removal of uncertainty and the ‘happening’ of the consequences of Brexit in full in 2021 will make investing in the UK a much more attractive proposition, because whenever there is major change, there are winners as well as losers. We can look for fund managers that we think know how to pick winners in a recovery situation.

I have thought for maybe 2 years that I wanted to participate in this opportunity. I bought UK value (ie out of fashion) and smaller company funds in late 2018 and 2019, thinking that the new Government was going to ‘get Brexit done’. In essence, although I did not wholly trust Boris Johnson, I though his election would unlock the Brexit process. For a while this seemed to have been a good call, but things went pear-shaped.

Even allowing for Covid 19 being a major spanner in the works this year, I was in any case misguided. I have only made money on the smaller companies fund, and given up and sold out of the value funds, because I expected to lose even more money in the near term. I would rather reserve the money in a defensive fund and buy at even cheaper prices. That sort of timing call has risks, of course, which is why I have titled this post as I have done!

I do not think any differently about the consequences of Brexit , only that my timing in buying into the most sensibly valued major stock market in the world was wrong (that happens to all investors sometimes, even the greatest). So I am once again looking for opportunities to buy UK shares at really cheap prices in the near future. I will publish some of my research soon!

Monday mashup – an Autumnal chill in the air

7th September 2020 by Mark Potter Leave a Comment

After a relatively non eventful August for markets (the steady climb in US market indices being almost volatility free of late), September kicked off with a bang.

Two declines and some stutters

Readers will have noted the sharp sell off, especially of the NASDAQ, last week, sharp enough to break some short term trading records, although only taking index valuations back a few days in reality – just very suddenly.

The fall in the dollar (until this morning, which change I don’t yet understand) suggested that markets were taking the same view that I expounded in my monthly commentary: that US interest rates are not rising any time soon and the the Fed may be the most accommodative of the global central banks.

This morning we see a very sharp sell off in the Japanese conglomerate Softbank (about which business I have written before). This is a business that appears to be operating to make money from trading the shares in other firms, not actually being interested in operating them. Such ‘corruptions’ of management as I would phrase it usually end in tears.

Other troubling stories are also rumbling around, like suspension of a rather obscurely run set of funds sold in the UK by Nataxis H2O, but after intervention by the French regulators.

Baillie Gifford, whose enthusiasm for Tesla stock seemed to be one of the main driving forces behind the share’s literally incredible rise have now sold out a large chunk of their holding and that spooked the markets too.

They say that the price rise had put the investment into an overweight and that must be true, but I wonder if even the manager of The Scottish Mortgage Trust (which now seems to be absurdly named given it invests mainly in US and Chinese technology and consumer services) has decided that he has travelled long enough on a bandwagon that he was helping to propel along with his legs over the side.

A technical helper on the extra volatility

Readers probably know that there are these days many millions of people trading in shares using newer technologies (mainly apps) who are without that much experience. I am not talking about people who build and maintain long term portfolios of funds but those who are often called ‘day traders’.

Because such people are often looking for a better life than one that has maybe not gone too well so far, they frequently start with very little capital, maybe even borrowing to get started. That makes it attractive for them to buy derivatives, rather than actual shares, because you get a large market exposure for not much money that way (ie you are ‘geared’). Courses are offered to people by experienced professionals to help them get started, but in my experience, even people sensible enough to take the training have only a limited understanding of what they are getting into.

One of the safer ways to play the markets with a small sum of money is to buy call options. For a premium that is much less than the price of the share or index you want to back, you buy the right (a contract) to purchase it (or a fixed number of shares in reality) at a future date at a given price. If the price is higher than the contract price on that date, you make a profit which might be a huge multiple of your small stake. If it lower, you let the contract lapse and lose your (hopefully) small stake.

Because the other party can just pay you out the excess profit on the shares if they are worth more than the contract price, rather than delivering the shares to you and obliging you to do the selling, the existence of such options in effect increases the number of transactions in those shares above the level of the real stock actually being traded

I can explain more, with examples, for any subscriber who wants a more comprehensive explanation, or you can take a look at Investopedia.

Heads they win, tails you lose

The reason for adding this educational note is to get you to think about the other side of the deal – the business that ‘writes’ the option. You might think that if you are buying a call option based on a share price rising and will profit if it rises a lot, the guy on the other side of the deal must be expecting it to fall and to be fleecing you for the premium when he is proved right.

That may be true, but actually, the other party may already own the share or index, or be capable of buying it and so has the risk of it rising covered.

If the share price goes up, they do only make the gain up to the option price because the excess goes to you, but that may be all they want in a rising market, bearing in mind that all the time they are collecting premiums (which might give them an income of 4% per annum, for example).

If we take a slightly deeper look at what happens when markets suddenly turn around, we shine a light on heightened market volatility. If your counter parts sees markets turning and a pretty high chance that you won’t make money on your contract, they are likely to sell the asset. They don’t need it to cover the risk of paying you out and they will look to bank any profit they have already accrued. They may even start ‘shorting’ the share.

So, without going into too much detail, we can say that the enthusiasm of a significant bunch of new investors for option contracts, which effectively multiplies up the trades in shares at market inflection points, is likely to also multiply volatility.

My balloon ran out of gas

Another well established influence on the markets is the ‘reversion to mean’ effect where the price of an asset will fall back sharply to its long term trend level when there is a relatively minor change in sentiment if it has moved a long way ahead of trend. Recent changes in the price of gold bullion can be seen doing exactly that if you take a look at a graph for the last few weeks

What goes up quickly may come down even more dramatically

These influences on volatility are like weather effects: a chill in the air, a dark cloud, a few drops or rain, even a rumble of thunder. They may only be transient, but they might also mean the end of Summer. It is best to look out your umbrella and even check where you put your heavy coat.

This is a notoriously hazardous time of year for investors. If you are sitting on worthwhile profits, you need to consider the relative risk of missing out on more upside versus the consequences of a sharp correction.

If committing cash to the markets, prudent investors will always want to be sure that the current price is good value. That may be so in some cases be the highest price ever paid so far, but that will not often be true.

It is always easier to make money buying when everyone else is scared after a rout. You may have to wait years for such an opportunity but keeping some cash on hand will be well rewarded in time.

Monday mashup – Look at the detail

24th August 2020 by Mark Potter Leave a Comment

It is easy enough to find quotes from ‘experts’ suggesting that stock markets have gone mad. Indeed I have written on several occasions attempting to explain why stock markets seem to be doing better than one would expect when we are are now into recessions in most developed economies, with probably worse to come.

But it pays to re-check the actual facts from time to time. Although some share prices have shot up, most of the time that is the claimed “V” or similar recovery shape from deep lows. Here are a few broader facts (data taken from the BBC):

The S&P 500 (the main US equity index) tech sector is up roughly 25% this year.
The energy sector of that index is down about 37% and the financials group down 20%. Overall the market as expressed by this index is up a little on its February 19th record.
Over half the shares listed in the S&P500 are trading lower than they were at the start of this year
The FTSE 100 is 20% LOWER than its January high.
The French CAC 40 is also down about 20%
The Japanese 225 index is within 4% of its pre-crisis high (that will be in Yen terms)

An analyst at the Dow Jones index company is quoted by the BBC as saying that the risks of the US election and the potential for disappointment if the recovery already anticipated by the market does not happen are reasons for caution.

My take is that in many developed countries there is no real chance of an economic recovery in the next few months.

I would expect a ‘lagged’ impact from the Spring lockdowns across the world and the temporary burst of consumer spending that is only a release of built up frustration to fizzle out as job cuts and reduced salaries begin to be felt.

The businesses that have benefited from the lockdowns will in some cases now see tougher competition. It has been reported that traditional retailers, having been forced into upping their game online, are now taking market share from Amazon.

That does suggest it is a good time to hold shares in businesses specialising in online retail technology and distribution, something some fund managers will have picked up.

I hope I am wrong, but I am deferring my hoped for return to optimism.

Monday mashup -1999 and all that

17th August 2020 by Mark Potter Leave a Comment

I am interested in psychology because I am interested in human behaviour, not just as it impacts on investments, but with all its joys and horrors.

There is a clear overlap between neurology and psychology and I have read that neurologists can agree with the idea that over time, our brains get programmed with biases, or ways of making decisions that are based on sub-conscious training of the process by past experience and maybe even inherited ‘coding’ of parts of our brains.

This is very relevant for investors who cannot avoid looking at the past when deciding how to position their investments for the future. If the past (insofar as we are aware of it) does not include any similar patterns to a developing situation, when that situation finally develops, we will be caught out – what has been called a ‘black swan’ event.

I think that where we are now with stock markets is actually a very white swan event. I have seen those birds ever since I was a little boy!

If one refers to the financial pages of newspapers and even web sites (which look oddly archaic) from 1999 – now a simple task thanks to Google, they read like they were written yesterday. What followed?

In March 1999, the NASDAQ peaked, then a whole series of events which were spread out over a whole year undermined the false and in some cases crooked (Worldcom and Enron, you may recall) valuations of many businesses. In the end, the NASAQ fell by around 75% – yes 75%! Other markets fell from the knock on effects and investors had to wait some 2 to 3 years to start making money again.

I read that in the second quarter of 2020 there were large net inflows into UK operated mutual funds (OEICs), with the exception of funds actually invested in the UK, which had outflows. Bond funds, index trackers and SRI funds all had positive flows of investor money. This was described in the article I read as ‘bargain hunting’.

If you want to see how history repeats itself, Google an article published by money.cnn.com called ‘Investing: 2000 and beyond’ and compare it with what pundits are saying now. Then check out what happened next to markets. You will find other articles if you have the time, referring to bargain hunters and new paradigms.

You will perhaps smile at the concluding advice in the CNN piece that US investors ought to reduce their market exposure to only 80% US and risk a whopping 20% elsewhere! In 1999, most UK investors would have adopted a similar stance and been heavily biased to their home market. If they were still doing that now, it would have cost them very dear.

I decided to write this post about the similarities with 1999 based on my own experience and memory, but notice while researching the history that many others, including academic writers, have seen the same swan sailing across the lake.

We can’t know that history will repeat itself, but they say that a fool is a person who repeatedly carries out the same actions and expects a different result. Maybe this time it will be different but do you want to risk it?