The difficulty lies not so much in developing new ideas as in escaping from old ones.
John Maynard Keynes
Our insights, reflections and musings on the most timely topics relevant to managing your investments.
Human nature is a funny thing. We tend to forget history quickly and then project the current situation into the future. The only thing that is truly constant in our world is change, yet most of us do not deal well with change. We fail to recognize that it has happened and then we fail…
After the initial “Trump rally” in the aftermath of the election the markets have really just been chopping along. There has not been much for us to write about. There has been plenty of politics, of course, but as our long-time clients and readers know, I try to stay out of that as much as…
In recent days I have been reminded of 1992. The recession that played a role in President H.W. Bush’s failure to get re-elected was over. It was over before the election even took place, but no one knew that on election night. Practically the next day the economic recovery was made public and President-Elect Clinton…
America is a special place. As a country, we used to understand that. It is not special because we are from here; it is special because it is truly different from the rest of the world. One act, by one extraordinary man, made America different. George Washington led a bunch of colonists against the world’s…
Arnold Palmer passed away on Sunday, and the legendary golfer and Demon Deacon will be deeply missed by both communities. Golf, like most sports, can teach a lot of life lessons. Simple yet complicated, rewarding yet frustrating…yep, that pretty much sums it up.
Human nature is a funny thing. We tend to forget history quickly and then project the current situation into the future. The only thing that is truly constant in our world is change, yet most of us do not deal well with change. We fail to recognize that it has happened and then we fail to appreciate that it will keep on happening.
This is true in many aspects of life, but I am thinking about the area I know most about, investing. The “Trump Rally,” which interestingly began in the third quarter of last year when Trump’s opponent was still well ahead in the polls (see what I mean about short memories), seems to be taking a rest. This rally has been strong and it has marked a change of course from the last several years.
We have been in a market where the only assets that were rising in value were the stocks of large U.S.-based companies. Even among those, it was only a select few. In such an environment, a few things happen. First, active managers who tend to believe in being diversified do not do as well. Secondly, international investments do not do so well. The last time we went through a period like this was in the late 1990’s as what later became known as the tech bubble was being inflated. When that bubble popped, we entered a decade where the only money to be made in investments was overseas. We also entered a period in which active managers thrived.
It is funny how that history gets forgotten. A few times in the last several weeks I have had someone tell me that international investments have lagged for 30 years. I’m not sure where this came from; it could have been an article that I missed, but multiple people have said the same thing. I have been working for most of that time and this was not my recollection, so I researched it.
I researched by going to the international funds we use with our various clients. Some of them do not go that far back, but two of them have 29-year track records. I figured that was close enough. The two funds are the American Funds EuroPacific Growth Fund and the Harbor International Fund.
I first compared the international benchmark, which is the MSCI EAFE index, with the S&P 500. Over the last 29 years the international index has indeed lagged. The S&P 500 has an average annual return of 10.33% while the MSCI EAFE has an average annual return of 5.35%. That is a lot of underperformance. The story changes a little when we look at the funds. EuroPacific has an average annual return of 9.27%, and Harbor’s average annual return is 10.42%.
There are no tricks here. I did not run any kind of search for the best international funds. I simply looked at the funds that we actually use with our clients which had track records going back that far. Two things happen: First, international investing looks a lot better when using actual international investments. Secondly, this puts into perspective the whole active vs. passive argument. We live in a world today where pundits love to abuse active managers and say crazy things like, “Why would you pay 0.50% more to be in an actively managed fund when active managers ‘never’ beat the index?”
These two funds beat their index by 3.92% and 5.07% compounded every year for 29 years. Remember that is net of their expenses, as mutual fund returns are always reported net of their expense ratio. If one had chosen an index option in this category the return that investor would have received is 5.35% minus that oh-so-reasonable expense ratio. Does that really sound prudent?
All manager styles will go in and out of favor over time. Harbor has been struggling as of late. But history tells us that whenever a majority of top-tier active managers underperform their index, it is because there is something wrong in the market. For international investors over the last thirty years there have been many market problems: Japan, pretty much the whole time. The Asian contagion of the late 1990’s. The Russian financial crisis. The war in Serbia. The European financial crisis. The index went through them all. Active managers didn’t, and that equals a 4 to 5 percent excess return annualized.
Will that happen again over the next thirty years? I don’t know, but my guess is something similar will, because as Mark Twain is reputed to have said, “History doesn’t repeat itself, but it sure does rhyme.” I hope I’m still here and get to see it. In the meantime, we will keep doing what has proven to work over time, even if everyone else has forgotten.
Chuck Osborne, CFA
After the initial “Trump rally” in the aftermath of the election the markets have really just been chopping along. There has not been much for us to write about. There has been plenty of politics, of course, but as our long-time clients and readers know, I try to stay out of that as much as I can.
The problem with our modern politics is that we are so divided. People no longer see political disagreements for what they are: two different views on how to solve a problem. They see them as black and white, good vs. evil. They see themselves in a struggle against some evil empire. No matter which side one is on they believe it to be the good side, and the other is the dark side.
Most of the time, if I do delve into this world of politics it is to remind our clients that this view is over-simplified and that we can’t allow our political views to hurt our long-term investment results. Most of the time.
But, today is different. We are a nation divided, and sometimes one must make a stand. He must stand up for what is right and against that which is evil. You have probably figured out by now that I speak of something far more important than mere politics. I’m talking about the Super Bowl!
Let’s face it: there is no middle ground. You are either a fan of the Evil Empire, aka the New England Patriots, or you have goodness in your soul. You either worship the Emperor (Bill Belichick) and his apprentice Darth Vader (Tom Brady), or you hate them and the evil for which they stand. You either think they are geniuses whose defensive schemes are always a step ahead, and whose passes are so perfectly thrown that the laundry list of re-tread receivers can catch pass after pass after pass due to the rebirth of having Brady, I mean Vader, as their quarterback…
Or, you understand what it means to steal play calls, and the more plausible explanation for receivers who failed to be able to catch fully inflated balls at their previous stops suddenly being able to grab every super soft pass thrown by the Lord of Darkness. You either believe in the old baseball saying, “If you ain’t cheating you ain’t trying,” or you are a fan of any NFL franchise not named the “Patriots.” After all, one man’s patriot is another man’s enemy.
What bearing does all of this have on your investment portfolio? Everything! It is a well-known fact (okay, actually it is more of a myth – but let’s not split hairs about alternative facts) that the stock market goes up when the NFC champion wins, and it goes down when the AFC champion wins. So, in the completely biased opinion of your investment adviser: If you wish for your portfolio to Rise Up in 2017, then we all need to be united. Everyone who is a fan of any NFL team not located in some general multi-state region; everyone who plays by the rules; everyone who believes in the good side of the force; and most importantly for our purposes, everyone who wishes 2017 to be a good year for their investments: Stand together. For as my city’s most famous citizen once said, “We must learn to live together as brothers or perish together as fools.” We must unite and Rise Up for the power of good to overcome evil.
Go Falcons!! Beat the Patriots!
Chuck Osborne, CFA
~Good vs. Evil
In recent days I have been reminded of 1992. The recession that played a role in President H.W. Bush’s failure to get re-elected was over. It was over before the election even took place, but no one knew that on election night. Practically the next day the economic recovery was made public and President-Elect Clinton received full credit. That is not unusual. When I was in high school, my political science teacher told a story about waiting for the train in Chicago the day after Ronald Reagan defeated Jimmy Carter. The train was late, and the lady next to him looked over and said, “The (insert colorful adjective) Republicans have been in office one day and they have already messed up the trains.”
Reagan had nothing to do with the train schedule in Chicago even once he was in office. Clinton had nothing to do with the economic recovery before he took office, and likewise this really isn’t a “Trump rally.” What is happening in the market today started in the third quarter. We are seeing the long-awaited rotation out of the so-called FANG stocks (Facebook, Amazon, Netflix and Google parent Alphabet) into the stocks which have been ignored or even beaten up over the last two years. The market stalled in October as investors waited for the outcome of the election to be known; once it was known, we went right back to the bull run. We will never know of course, but I suspect the outcome would not be terribly different had the election gone the other way.
The stock market may react to political events in the short run, but in the long run it is the results of the companies and the price of their stock that matter. Lost in this election speak is the improving health of corporate America and the low price at which many stocks are currently selling.
Yes, markets are at record highs as measured by several indexes. However, that fact is skewed by a handful of companies whose stocks are selling at outrageous prices. Those stocks actually have been going down since the election, while the larger number of companies whose stocks are cheap have seen a great rally.
The question of whether a Trump administration will be good or bad in the long run will depend, as with all administrations, on what he actually does once inaugurated. If his administration promotes good policy, then we will get good results; If not, we won’t. Either way, the United States of America will survive. I have been fortunate enough to live through several administrations – some for which I voted, many that I did not, but all of whom were my president. I didn’t always realize that in my youth, but one day you grow up and understand that this is the beauty of our republic. In the immortal words of Mick Jagger, “You can’t always get what you want. But, if you try sometimes, you just might find, you get what you need.”
Regardless of politics we still have much for which we are thankful. In keeping with our tradition, here is my own list:
I am thankful…
Chuck Osborne, CFA
America is a special place. As a country, we used to understand that. It is not special because we are from here; it is special because it is truly different from the rest of the world. One act, by one extraordinary man, made America different. George Washington led a bunch of colonists against the world’s preeminent military power and somehow won. After victory, the people of America did what people around the globe have done since the beginning of human history: They went to their leader and asked him to be their king. But, George Washington did what no other leader, of which I am aware, in all human history did: He said no.
Washington said that we didn’t need a king, and the American system of democracy was born. That one act makes us unique. It is not the only thing that makes us unique, but it may be the most important. We do not, have nor have we ever, had a monarch. We have a system of checks and balances made up of three separate but equal branches of government.
I believe we could use that reminder as we head to the polls. Friday on CNBC there was commentary about the economic ramifications of both major presidential candidates. One commentator asked what would happen if Trump wins and decides to shut down the Federal Reserve. One simply cannot make this up – this was not some “person on the street” clip where they make fun of the ignorance of the average bystander. These were the professional market pundits to whom investors listen every day. The Federal Reserve was brought into existence through an act of Congress. The president of the United States does not have the authority to abolish an act of Congress. Every American citizen who had a passing grade in 8th grade civics should know this. However, the college-educated broadcasters on CNBC seemed to be completely unaware.
People, frankly including myself, seem distressed about this election more so than any election in my lifetime. We have heard from many clients who are concerned about what will happen in the capital markets after the election. While I understand and share the unease with the two major candidates, when it comes to what will happen in the markets after Election Day there are three things to keep in mind.
First, we must remember our civics lessons. We are voting for the president, not the monarch. We are also voting for Congress and the Senate and state and local politicians. We may be voting for local ballot initiatives. We are voting for all of government, and our government is mostly decentralized. The two presidential candidates cannot do most of what they have promised to do without the consent of Congress. Donald Trump cannot shut down the Fed or ignore existing trade deals, and Hillary Clinton cannot raise taxes on anyone. Congress holds the power.
Second, while outside events can have temporary impacts on markets, ultimately we are investing in companies. Apple will continue selling iPhones regardless of who is in the White House. People will still drink Cokes and watch TV and go to the grocery store. Prudent investing is done from the bottom-up, so what matters is what is happening at specific companies. There may be some companies that are impacted by policy, but that always happens, and there are usually just as many winners as losers.
The market does have expectations. The market consensus belief is that Hilary will win and the Republicans will keep control of Congress. Mind you, this is not an indication of what Wall Street wants, it is simply what they believe will happen. The investment industry is a diverse industry, and like most industries it employs people of differing political views. However, when it comes to our day jobs it is a matter of understanding probabilities. The highest probability is Hilary wins a close election and Congress remains in the hands of the Republicans. If something other than that happens then, like any surprise, the market will likely react. That reaction will be short-lived and a few days later we will be back focused on company earnings.
Third, we have already had the reaction. The “smart” money has been on hold for the month of October. The market has had a stealth correction with stocks going down, but on very light volume. This means that most large investors have been simply sitting on the sidelines and waiting. No one has a crystal ball, but our best estimate is that the worst-case scenario is that the big investors just stay on the sidelines. The most likely scenario is that these investors have developed two different playbooks depending on the outcome of the election, and they start buying based on those playbooks once the outcome is known.
This election has been unique from the beginning. It may have an impact on future policy and the direction of our country. It is important. They all are. However, the world will not end if your candidate doesn’t win. We have a lot of problems in our country. We always do. We also have a lot of positives and sometimes we seem to forget that.
The Chicago Cubs just won the World Series. The Wake Forest Demon Deacons just won their 6th football game this season and are going to go to a bowl game. Michael Smith, our Director of Research, and his wife Sara just had a healthy baby girl. Good things are happening every day. We’ll get through this election one way or the other.
Chuck Osborne, CFA
“Golf is deceptively simple and endlessly complicated; it satisfies the soul and frustrates the intellect. It is at the same time rewarding and maddening – and it is without doubt the greatest game mankind has ever invented.” – Arnold Palmer, 1929 – 2016
Yesterday was a sad day for golfers and a sad day for the Wake Forest Demon Deacons, and since I am both, I’m sad. Arnold Palmer passed away on Sunday, and the legendary golfer and Demon Deacon will be deeply missed by both communities.
Golf, like most sports, can teach a lot of life lessons. If one were to take the quote above and replace the word golf with investing, and the word game with pursuit, then he would have pretty well summed up what it is like to be a professional investor. Simple yet complicated, rewarding yet frustrating…yep, that pretty much sums it up.
Just last week I welcomed a visit from the Chief Investment Officer of a New York-based investment firm that has a stellar long-term record but has been struggling in the recent environment. They are by no means alone. He was telling me that they have been losing clients and that the majority of them have been going to so-called passive index-based fund options. Of course this appears to be happening just as their results are improving. In fact, quarter to-date their flagship fund was well ahead of the index returns, but so many times decisions are made looking in the rear view mirror.
He and I lamented that we live in a world where few seem to ever slow down and ask the simple question, “Why?” For the last year and a half if not longer, the stock indexes have been delivering better investment results than the vast majority of quality investment managers. To be clear, I’m not talking about the average investment managers. Index true believers will tell you all the time that the index beats average. In other words, the index is usually a solid C+ student. However, lately the index has been getting an A+. Most people just look at this and say, “Those other managers are just too dumb to beat their benchmark.” We on the other hand want to ask, Why?
Why all of a sudden is the index beating the good managers? During Iron Capital’s 13-year existence, on average two thirds of the managers we use beat their benchmark for any given three-year period. Quality managers do exist, and they can be identified. So if they are smart when they succeed, did they all just simultaneously become dumb? I don’t believe that.
To get to the real answer one has to understand how an index return differs from that of an active manager. The return of a whole portfolio is simply the returns of the stocks of all the companies in that portfolio. If two portfolios differ in their returns, it is usually because they own different stocks. So, if the index is delivering better results this means that the stocks that are doing the best are stocks that no quality manager wishes to own.
That to me is a signal that something is wrong. The last time this happened was the internet bubble – that time when stock prices were being driven up by the excitement around the internet. Anything internet-related did well, while the stocks of other companies were ignored. Quality managers don’t typically chase pipedreams, so they didn’t keep up with the index. We remember how that ended. For a decade after the bursting of the bubble, almost every active manager (even the C students) beat the index.
Today it is all about the Fed. The Federal Reserve just met and decided to leave interest rates unchanged for now. That means record-low interest rates, and not just here in the U.S. Both Germany and Japan currently have negative interest rates – meaning that they are promising those who loan them money to pay back less than what they borrowed.
There are two beneficiaries of this policy. The most obvious is the dividend-paying stock. Retirees and other investors who need to produce income would normally invest in bonds. However, when bond yields are so low, they cannot produce adequate income to meet the needs of most retirees. This causes investors to abandon bonds for typical income-producing stocks, such as the stocks of utility companies. Many utilities are now selling for prices usually reserved for the fastest-growing technology companies.
The other area that has benefitted from recent Fed policy is the so-called FANG stocks. FANG stands for Facebook, Amazon, Netflix, and Google, but the phenomenon is not limited just to these four. Basically any company whose future is tied to either your mobile device and/or social media has seen its stock price rise. This is less obvious to many, but this is a result of low interest rates. Long-term interest rates are an indication of what investors believe about future growth. When our ten-year Treasuries are paying less than two percent, it indicates that investors believe growth will be less than two percent. In that environment investors look for companies they believe can grow regardless of economic conditions. The FANG stocks match that criteria.
Just like the late 1990’s, today all the stocks not meeting the criteria du jour have been ignored and that is where the quality managers find opportunities. Those opportunities can be rewarding, but it takes patience. In the meantime, the markets can be frustrating. There are signs that patience is beginning to be rewarded. My visitor last week informed me that I was the last stop on a three-day tour in Atlanta and I was the only one they met who was optimistic, which of course made me even more optimistic.
Arnold Palmer drew people to golf and to himself largely because of his optimism. There was never a spot on the course where he couldn’t see a way out. Sometimes this led to frustration, but it often led to reward. It was certainly part of what made him the King. We have been in a frustrating market, but the reward looks like it is coming. Mr. Palmer may have been talking about golf, but it could have been just as easily about investing, or for that matter life. Rewarding and maddening all at the same time, that just about sums it up.
Chuck Osborne, CFA
~Lessons for Investing from a Legendary Golfer