Amen of the Week:
“It became very clear to me sitting out there today, that every decision I've ever made, in my entire life, has been wrong. My life is the opposite of everything I want it to be. Every instinct I have ... It's all been wrong.”
- George Costanza, Seinfeld, “The Opposite” episode, 1994
Try this for fun: At the next cocktail party you attend, survey the room and think to yourself, "What’s the dumbest thing that I could say to each person in this room?" In 1999, that would have been predicting that the S&P 500 would be lower in ten years’ time. If that weren’t enough to brand you the moron in the room, you could have topped it by predicting that Yahoo! and AOL would wither. (For you youngsters, those were the Google and Facebook of olden times.) In 2007, it would have been that housing was not a good investment. In 2009, it would have been that stocks are a good investment.
Not only is this a fun way to entertain yourself at a stuffy party, it’s an instructive lesson in successful investing. It reminds us to be skeptical when everyone else believes something to be a definitive truth. Simultaneously, where others are skeptical, we should seek opportunity. This is why investing confounds some of the smartest people. They expect logical thinking to be rewarded. It is, but with a caveat: it cannot be popular logical thinking. In every other field besides investing, if you follow the crowd of smart thinkers, you will almost certainly achieve great results. This is because in fields like medicine or engineering, the popularity of an idea does not negatively affect its outcome. If anything, the more popular an idea becomes, the more it is refined and vetted, which can lead to improved outcomes. With investing, just the opposite is true: the more popular the idea, the worse the outcome. If everyone agrees a company is super great and buys the stock, that drives up the stock price to the point that future returns are diminished – if not erased. For logical thinking to reward an investor, it must lead to a differentiated view. Even George Costanza discovered this in the greatest Seinfeld episode ever filmed.
Which leads us to the question: what is the dumbest thing that you could say at a New York cocktail party? Surely it is that you are unequivocally bullish on stocks. How dumb would that sound! Warren Buffett doesn’t frequent these kind of parties, but he’d be the one guy in the room who’d agree with you. In Berkshire’s 2014 annual letter (published when stocks were near current levels), he wrote,
“The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency... To one degree or another it is almost certain to be repeated during the next century. Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions.”
The paradox is that stock prices today are richly valued.* This traditionally would imply lower real returns in the future, which is precisely why so many professionals, myself included, are so cautious today. I remain open-minded, however, that today’s caution might win the battle but lose the war. Specifically, the war against inflation. Today’s stock prices imply lower future returns in real terms. Yet, in nominal terms, stocks could rise substantially in the decade ahead if we were to experience a surprisingly high inflation (as all past high inflations have been – a surprise). Predicting inflation is perhaps the most absurd thing you could suggest today. Even George would have trouble believing that. Keep in mind, though, that governments in every major country are coordinating to create inflation – in large part to deflate their crushing debt burden in dollar/euro/yen terms. If they succeed, stocks will be one of the best ways to preserve wealth in real and nominal terms.
Today we are all faced with a cruel paradox, one that we should deeply resent policy makers for having created. Millions of retirees find themselves forced to pick a poison: accept greater risk today (buying over-valued assets) in order to reduce the longer-term risk (and the greater risk) of outliving the savings they’ve worked a lifetime to accumulate. Fielder can help investors navigate this cruel paradox by helping them thoughtfully plan their cash flow needs, custom tailor their portfolios accordingly, and reduce unnecessary costs/fees/taxes.
Yours in the Field,
Frank Byrd, CFA
*Based on stocks’ CAPE and Q-ratio in comparison to historic levels.
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