Originally I cited another piece of my anatomy, but this is a family newsletter. The bizarre weather week we had in Atlanta has finally come to an end, and everything is back to normal. The streets are clear, mail is running, and even the Falcons resumed normalcy and will be watching the remainder of the NFL playoffs from the comfort of home as usual.
Investing is often described as being part science and part art, but in reality it is part finance – which may or may not be science, and part psychology – which may or may not be art. The wonders of human psychology were all around us here in Atlanta last week, and I think much can be learned from what we witnessed that can benefit our never-ending search for investing wisdom.
First, for the majority of you who are not in Atlanta, let me attempt to set the stage for you. It does not snow often in Atlanta, but when it does, it is always much worse than when it snows in more northern places. I have spent the vast majority of my life in the South, but I did spend four years in northern Indiana, and what I remember about those winters is as follows: it would snow and be very cold until it warmed up and the snow went away. That does not occur in Atlanta. Here, it snows, warms up, then gets cold and freezes the half-melted snow, creating ice. Once that happens it really doesn’t matter what kind of tires you have or how many of your wheels are attached to the drive train, or for that matter the years of experience one has driving on snow before moving south. The entire city shuts down, paralyzed by ice, US Postal Service included.
Fortunately in Atlanta this happens only once every few years and usually lasts one, maybe two days, before our winter temperatures are back up in the 50’s. Except this year. People were stuck for an entire week, and they did not like it. This is where human nature comes into play. Every night the local news was interviewing local residents, many of whom have moved to Atlanta from Boston, New York, Chicago, and other frequently snowy regions, and every night the people were saying the same thing: Where are all the snow plows and ice trucks? Why is the City of Atlanta not prepared for this? They should have more snow removal equipment!
Herein lies the lesson for investing. One of my mentors used to pound into my head that you manage to the norm, not the exception. That sounds so simple, but it really goes against human nature. When we are stuck in our homes and our driveways and streets are solid ice, we want to know why the city doesn’t have enough snow plows. (Zambonies probably would have been more helpful, but the people cried for snow plows.)
I have lived in Atlanta for 19 years and nothing like what happened last week has ever happened. One of my neighbors, a retired minister who has lived here her entire life, recalls a similar storm in 1973. It would be foolish for the city of Atlanta to invest in a fleet of snow removal equipment to rival cities like Boston or Chicago when something like this happens only every few decades.
We should certainly be prepared for such rare but devastating events (and for the record there are reasonable things Atlanta could have done better in response to this storm), but we must remember that such events are the exception. This is surprisingly hard; humans seem wired to believe that what is happening now is what is going to happen for the rest of eternity.
In the investing world this mentality consistently leads to projections that are either overly pessimistic or overly optimistic. Today we see pundits talking about double-dip recessions and deflation one minute, and three positive data points later the same pundits are talking about rapid growth and the threat of inflation. Reality lies somewhere in between.
This leads us to our projection for 2011: We think the S&P 500 will be up 10% in 2011, a little worse than 2010 but still solid. We think it will continue to be a rough ride, three steps forward and two steps back, as much of the global economic uncertainty of 2010 remains. We believe large caps will outperform small caps and international will continue to lag.
We are very concerned about bonds, and expect negative returns in treasuries as interest rates rise. The big unknown for 2011 is how fast and how far interest rates will go up. The biggest risk to our equity market projection would be rates rising much faster than expected, which would spook the markets.
Many will think we are foolish to believe that large-cap US equities are the place to be after they have gone nowhere over the last ten years. But then again, there are a lot of people who think Atlanta needs a big fleet of snow plows. We’ll stick to managing to the norm, and the norm says it is usually warm in Atlanta and that putting money in equities after a ten-year secular bear market is usually a very profitable thing to do.
Chuck Osborne, CFA
Managing Director
