The stock market is filled with individuals who know the price of everything, but the value of nothing.
Philip Arthur Fisher
Iron Capital’s quarterly investment newsletter through which we share our views on investing your assets in the current market environment.
Iron Capital is a living, breathing firm, and it must grow so that its employees can grow. People need raises, healthcare costs rise – everything is always going up, so we as a firm must grow as well. How do we do so if we don’t have salespeople? I have always believed that if we take care of our clients, then they will take care of us. So we focus entirely on taking care of our clients.
Henry Ford did not invent the car; what he invented was so much more important than that. This is the power of capitalism: It is a constant process of making the luxuries of our time more accessible. So why does capitalism get such a bad reputation?
The investing world is chock full of clichés. A recent commercial recited one of the more nonsensical clichés of our industry: “He didn’t plan to fail, he failed to plan.” Come to XYZ financial and we will create a plan that works for you. In the words of Fluffy Watts, what a crock.
Understanding the psychology of the market can be a great tool, especially when added to a scientific approach. Investing is part science and part art; it is not 100 percent either of those things, and do not let anyone convince you otherwise.
I have struggled with what to say in this Quarterly Report. It seems somehow inappropriate to discuss any topic other than the virus. As I was leaving my office one day, I heard one of the CNBC talking heads say, “I’m scared to death of this virus, as I know we all are.” It hit me because I am not afraid of the virus, and I do not believe I am alone.
I am a proud member of the “Seinfeld” generation. We can communicate in short, seemingly meaningless phrases, and we know exactly what the other person means because of the cultural phenomenon that was the “Seinfeld” TV sitcom. One such phrase is, “No Soup for You!”
A New York City chef had opened a restaurant specializing in soup, which he served himself. The only issue was that the customer had to order the soup in a specific manner. If the customer got it wrong and upset the chef, then it was, “No soup for you!” He got away with this behavior because his soup was that good. Well, Jerry and his friends came to enjoy the soup and hilarity ensued. The bit was so funny that it went on for multiple episodes. The chef was known as the “Soup Nazi.”
At Iron Capital we are often asked, “What is your minimum?” The answer to that question is technically $1 million, but we are allowed to make exceptions, and we usually respond by telling the prospective client that we have never turned anyone away because of a lack of assets. The reason is very simple: We do not view our clients as dollar signs. This is one of my pet peeves about our business. Several years ago we tried having salespeople. We hired experienced staff from our industry. When they uncovered a promising new prospect and came to tell me about it, they would habitually started with, “She has $X in her portfolio.”
I would always tell them that I didn’t care about that; what I wanted to know is, who is this prospective client? Why is she interested in working with us, who referred her, and what is she looking for in an advisor? I wanted to know about the person, but the sales mentality went immediately to the dollars.
It was not their fault. They had all come from the industry, and this is how our industry works. In the industry people think nothing of asking, “What are your assets under management?” I understand what they mean, but the truth is Iron Capital, like every other firm out there, has no assets under management. Our clients collectively have more than $5 billion that they have entrusted to us to advise or manage, but not a dime of that belongs to Iron Capital. Those assets belong to our clients, who have largely entrusted us with the bulk of their assets, which they rely upon to provide for their various financial goals.
We tell our staff all the time: It does not matter how small a portfolio may be compared to others we manage, it is all the money in the world to that client, and he is just as important as every other client. Our responsibility to him is just as great – and perhaps even greater because he has less of a margin for error. This is our culture and it is why, for several years now, we have no salespeople. We are entirely referral-only, so people must come to us, as we have no one whose job it is to seek them out.
Once a prospective client understands that we are not concerned with their level of wealth, they usually ask the next logical question: “So have you turned people away for other reasons?” The answer is yes. If we feel that a prospective client is not a fit with us culturally, then we will politely tell them that we do not believe this is a fit, and we wish them the best of luck.
That is right – sometimes we say, “No soup for you!” (Much more kindly, to be clear.) Why would we do that? It is not because we are some form of financial advice Nazis; it actually has to do with the fact that we have no salespeople and we do not make any effort to seek out new clients in the first place.
When people from the industry hear that we don’t market ourselves to new clients, at first they often just don’t believe it because, to my knowledge, it is completely unique. They will ask, Aren’t you concerned with growth? Of course I am – people, plants and firms are all either growing or decaying. Growth is necessary for life; this is something the capitalism-haters simply do not understand, but that is a topic for another day.
Iron Capital is a living, breathing firm, and it must grow so that its employees can grow. People need raises, healthcare costs rise – everything is always going up, so we as a firm must grow as well. How do we do so if we don’t have salespeople? We rely on our clients. I have always believed that if we take care of our clients, then they will take care of us. So we focus entirely on taking care of our clients.
How do I get everyone on board with this strategy? I compare it to the Spanish conquistador Cortez, who famously burned his ships upon arriving in the New World so they had no choice but to conquer and settle the land. His men’s brutality is legendary. We don’t want brutal at Iron Capital, but I basically tell our employees that relying on a sales staff for their own raises is not an option. If they want to grow in their careers here, they will take care of our clients or go work somewhere else. Our investment professionals must grow the portfolios we actually manage, and our service professionals must take care of the clients, because we are not getting new ones.
That is not exactly true. We get more than enough new clients; they all simply come from our existing clients. This only happens because we are laser-focused on keeping and growing our existing client relationships, which is exactly why we don’t take every single client who comes our way. Don’t get me wrong, it isn’t like we turn down all that many, but it does happen.
Our clients understand that we are firm believers in what we call prudent investing. We invest from the bottom-up; we are absolute return-oriented; and we are risk-averse. Our clients understand this, and most of the time this is exactly what their friends want when clients refer them to us. However, we also will get random calls from someone who read about us or saw our name on a list of successful firms. Nine times out of ten these cold prospects start by asking questions that send up red flags, like, “What have your returns been?” And they often start by telling me how much money they have when I ask about them.
These individuals have unfortunately been conditioned by the industry to believe in competitive investing. Most of the time, this would be good for us; we know what we are doing, yet there is no investment strategy that is always successful in the short run, and there is no long-term success without a consistent strategy. I’m not saying that our way is the only way, but one has to pick a way and stick to it. These clients would be our new clients this year and someone else’s new clients next year. Why do we care? Why wouldn’t we just be happy collecting our fee for a year?
Because of you. The time spent on these kinds of clients is time that we can’t spend taking care of our real clients. Then, when they leave, their new adviser will likely sell everything we put in their portfolio, which means they will be selling many of the investments that are in your portfolio. We don’t want that.
So yes, we are selective, but it is not because we are arrogant or believe that only a certain kind of person deserves our help. We are not the investment world’s Soup Nazi; however, if we believe a new relationship will hurt our existing relationships, then it is, “No soup for you!”
Chuck Osborne, CFA
~No Soup for You!
A few years ago I was sitting in church paying close attention to the minister’s sermon when he mentioned that Henry Ford had invented the automobile. He lost me right then and there, because for the rest of the sermon I kept wanting to shout out, “Henry Ford did not invent the automobile!” I kept looking around and thinking, “Certainly these people know that Henry Ford did not invent the automobile.”
The automobile, like most inventions, evolved. Stating clearly who really invented it is difficult; however, most give credit to Karl Benz, who made the first car with a gasoline-powered internal combustion engine. His car had three wheels. Shortly afterward, Gottlieb Wilhelm Daimler created the first four- wheeled automobile. Both men were German, and, of course, they eventually formed Daimler-Benz, which continues to make the Mercedes Benz to this day.
Why the confusion? I believe it comes from a lack of understanding of capitalism itself and, in particular, capitalistic innovation. To understand what I mean, we need to look at what Henry Ford actually did invent: Henry Ford invented the assembly line, which is a far more capitalistic invention.
What do I mean by that? Henry Ford took an invention which, until that point in history was available only to the very wealthy, and found a way to produce it at a cost that all of his workers could afford to pay. This is precisely what capitalism does: it finds ways to provide the masses access to luxuries that were once available only to a select few.
There was a second part to that: He paid his employees enough to be able to purchase a Model T. This is also part of capitalism. In thirty years of business, I have yet to meet a successful businessperson who did not feel passionately about taking care of his or her employees. This is not to say I have not met such people; I have, and invariably they are the ones whose business is constantly struggling. One of my old bosses used to say, “Our most valuable asset goes down the elevator every night.” Human beings only work well for someone who actually cares about them. The world is full of middle managers that do not understand this basic principle, which is why they will never be more than a middle manager.
The image today of capitalism is one of oppressed workers and an owner class that wants to raise prices in order to maximize profits for themselves. This image is one of pure ignorance. It comes from people who have no understanding, and frankly do not want to have an understanding. They shout down anyone who dares to say, “Look at the facts.”
Having said that, the image of capitalism is not completely negative. People believe that capitalism leads to invention, and this is also not really the case. It is far more accurate to say that capitalism leads to innovation, and there is a huge difference. Innovation involves items that have already been invented; it finds new ways to use them or make them. It does not create something new out of nothing.
The late Clayton Christensen was a Harvard Business School professor and the pioneer of the concept of disruptive innovation. Ford’s Model T and the assembly line that made it possible is a perfect example. The automobile industry had been around for 30 years when Ford launched the Model T in 1908. His innovation was not a better car, but a car that was affordable to those who previously could not afford a car.
Christensen argued that a disruptive innovation was an innovation that created a product that was not as good as existing products, but good enough and a fraction of the cost. The Model T was not a better car; it was an affordable car. Fast forward 70 so years and a young Bill Gates started a company with a mission. His mission was not to become the wealthiest person on the planet, although he did end up holding that title for a while. His mission was to put a personal computer in the home of every American.
Those early computers, running the Microsoft DOS operating system, were not anywhere near as powerful as the mainframes that technology professionals had access to, but they did what most people needed at a fraction of the cost. They kept improving and improving until one day a man name Steve Jobs said we can put a PC in the pocket of every American.
Those phones and tablets were not as powerful as the desktops of the time, but they did what was needed at a lower cost, and we could have them with us everywhere we went. Disruptive innovation – that is what capitalism actually does.
Perhaps the best example in recent years is Roku. For those who are not familiar, Roku is a service that is installed on some televisions, or one can buy an add-on device, which allows for easier access to programing that is streamed over the internet instead of the traditional cable TV system. In other words, it allows one to “cut the cord.” We did this in our house about four years ago.
Streaming, whether through Roku, Apple TV, or other such device, was not as good as having cable. It did not offer the hundreds of channels or the guide or the ease of recording shows that our state-of-the-art cable service provided. However, we could get just about every channel we actually ever watched with the flexibility to change plans monthly, and with streaming content, the need to record things on our own devices was pretty much gone. In other words, it wasn’t quite as good, but it was good enough, and it saved us considerable money.
This is the power of capitalism: It is a constant process of making the luxuries of our time more accessible. So why does capitalism get such a bad reputation? Where do the critics go wrong? There is confusion, especially in politics, between capitalism and business. Disruptive innovation, the life blood of capitalism, does not come from big established companies. In fact, disruptive innovation destroys big established companies.
Most successful businesses start out as innovators, or copycats, but either way they are providing consumers with something of value that was either unavailable or really expensive until that point. Then they grow. Then they start to slowly lose the ability to innovate. Then they start to listen less and less to their customers and more and more to Wall Street analysts.
Then the death knell rings: As their business matures and starts to slow down, they hire consultants – young, intelligent, ivy league-educated people who have never actually done anything in their lives, who are now going to tell these seasoned businesspeople how to run their company. This is when a switch is flipped. The company that was all for free markets before suddenly thinks regulation is a good idea.
Don’t believe me? These very words came out of Mark Zuckerberg’s mouth just a few months ago. “From what I’ve learned, I believe we need new regulation….” Of course he does. Zuckerberg is no longer a capitalist; he has become the owner of an established big corporation, and innovation is now a threat. The greatest protection from innovation? That would be regulation.
In economics we call this rent- seeking. Any regulation of social media would have a marginal impact on most of us, but an enormous impact on companies like Facebook. This provides social media companies with a strong incentive to lobby for favorable regulation while the rest of us have little incentive to do anything. Regulation usually enshrines the status quo and makes it very difficult for potential competitors. That hurts capitalism, but helps business.
The most extreme examples today would be in places like Russia. Putin is certainly no free market advocate, but he loves the oil business. He is all for Russian oil interests, and running an oil company is a great gig in Russia, as long as you remember who the real boss is. As I write this Jack Ma, the founder of Chinese technology giant Alibaba, is missing. In late October he made some public comments that were less than flattering towards the Chinese regulators. He has not been seen in public since. China loves big business – the jobs they provide, the income to the state – but they have soured toward capitalism over the last several years. Too much freedom.
Innovation requires freedom, which, in the end, is what capitalism actually means. As Milton Friedman said, “Underlying most arguments against the free market is a lack of belief in freedom itself.” Especially the freedom to earn a profit. Profit is a bad word; it is associated with greed and the cutting of corners. This is only really true if profit becomes the purpose of the business. This, unfortunately in my opinion, is often taught in business schools: “The purpose of a corporation is to increase shareholder profits.”
That is just wrong. Profit is an absolute necessity of survival, and that is true whether we are talking about corporations, individuals, or charities. Every entity must spend less than they bring in if they wish to be sustainable, and spending less than what is brought in is the definition of showing a profit. Being profitable is a necessity of business, but it is not the purpose. Innovators are people of vision, and their desires are far loftier than money.
Henry Ford wanted every American to have a car. He was a businessman, and he knew a profit was necessary for survival, but his purpose was to build cars that everyday Americans could afford. Bill Gates wanted to put a PC in the home of every American. Jeff Bezos has ignored profitability perhaps more audaciously than any business leader of our time while building an empire at Amazon. Great companies all have a higher purpose. There is a move a foot today for so-called “stakeholder capitalism,” which means running a business for more than just the shareholders. My take on this is that it is much to do about nothing, because all truly great businesses have always cared for employees, their communities, and the world around them. One cannot be successful for any period of time without caring about these things.
Only in the classroom does business care only about shareholders, or to be more accurate, only in the classroom does caring for shareholders not include taking care of employees and the community, etc. Businesses that do not do these things do not stay in business, and nothing destroys shareholder value like going out of business.
Henry Ford did not invent the car; what he invented was so much more important than that. He showed the way for Bill Gates, who did not invent the computer, and Steve Jobs, who did not invent the cell phone, and Jeff Bezos, who did not invent the internet. The disruptive innovation of capitalism has improved the lives of the masses in too many ways to count. We need to think about that when people start vilifying and calling for change without even understanding what Henry Ford actually invented.
Chuck Osborne, CFA
~Henry Ford Did Not Invent The Automobile
My father was an athlete. He lettered in three sports in college, but football was his favorite. He loves telling the stories from his days playing, and his high school coach had an enormous influence on him. One of my favorite stories comes from a time when they had lost a tough game on the road. They were loaded in the bus ready for the trip back home when his coach, Fluffy Watts, stood up in front to address the team. He said, “They say it isn’t whether you win or lose that matters, but how you play the game…. well, what a crock.”
I have heard that story hundreds of times, and I laugh every time, in fact I’m giggling right now. I laugh because I believe I understand what Fluffy was doing. I played high school football myself, and like every single other person who has ever been part of a team sport, I know what it feels like to lose. It hurts, and the closer the game, the more it hurts. People who have not experienced this may not understand that statement. Many believe it would hurt more to get blown out, but they are wrong. When a team gets blown out, well it just wasn’t our day or they were just better, but when it comes down to the wire and then goes the wrong way, that is the agony of defeat. Fluffy Watts was not suggesting that his team should do anything to win. I never met Fluffy, but I know my father and how he speaks of him. He was a man who demanded good sportsmanship above all else, but he also understood that when someone is in pain, empathy is often better than a speech about holding your head up.
A friend of mine I used to work with used to say that clichés exist for a reason. He is right about that. “It isn’t whether you win or lose that matters, it is how you play the game” exists for a reason. It is better to lose fair and square than it is to cheat and lose your integrity, but it is also correct that, “If winning didn’t matter, they wouldn’t keep score.” Clichés have their limits.
The investing world is chock full of clichés. Recently I was watching a commercial that recited one of the more nonsensical clichés of our industry: “He didn’t plan to fail, he failed to plan.” Come to XYZ financial and we will create a plan that works for you. Well, in the words of Fluffy Watts, what a crock.
I have written this many times, but I have a true dislike for the term financial planning. This lies mainly in the fact that I understand its history. “Financial planning” evolved from the life insurance industry. A few days after Cain killed Able, some neighbor went over to Able’s widow and instead of offering sympathy said, “Wouldn’t it be great if a company showed up at your door with some money to replace your husband?” The life insurance industry was born, and for years that was pretty much how they sold their policies.
Then one day an enterprising insurance agent realized that they could sell a lot more insurance by calculating the husband’s lost wages, as opposed to taking advantage of the heartstrings. Losing a husband was one thing, but losing the household income? Now that was serious. This new strategy was named the capital needs analysis. Instead of simply asking, “How much is your husband worth?”, the insurance agent could say, “How do you plan to replace your husband’s income?”
Capital needs analysis is simple math. If the husband made $50,000 per year and one could invest capital and receive a yield of 5 percent annually, then the wife needed a life insurance policy on her husband of $1 million. The agent would say it using his best Dr. Evil imitation, “One million dollars.”
It is simple math: 5 percent of $1 million is $50 thousand. That is the income that needed replacing. This was great for the life insurance industry. Much bigger policies could be sold by using this needs approach.
Then needs analysis started getting more sophisticated. The simple example did not factor in other assets available to produce income. There could be retirement plans and home equity. Did the widow need all of her husband’s income? After all there would be fewer tee times, and hunting trips. The beer budget could be cut by 80 percent or so and they could cut the cable on the TV. All of this budgeting needed to be done.
What happens if we make it to retirement? We no longer need insurance to replace income because our retirement plan is doing that. Then the insurance agent thought of something. There are three possible futures, one in which we die too soon, one in which we live too long, and one in which we get disabled in the process. He can sell insurance for all three of those outcomes. We can use the needs analysis framework to calculate how much we need to save in order to retire, in addition to both life and disability insurance needs. Financial planning was born.
For years financial planning was code for being a life insurance agent, then stockbrokers got in on it, too. So, I dislike the term financial planning because in its essence, it is a sales pitch.
Please don’t misunderstand. The analysis done in the planning process can be very helpful, and we do that for our clients all of the time. Having a plan can certainly be of great value. However, there is another cliché about that. “No plan survives contact with the enemy.” That is what they teach soldiers during boot camp. Mike Tyson put it more bluntly when he said, “Everyone has a plan until they get punched in the mouth.”
When I saw the commercial for the poor guy who “didn’t plan to fail, but failed to plan,” my first response was, “On what page in the plan did they explain 2020?” The plan covered COVID-19, lockdowns, and civil unrest? I don’t think that was in there. So, for the restaurant owner whose business has been shut down, was it really a lack of planning?
Plans can be very helpful, and I certainly don’t wish to suggest otherwise, but the difference between failure and success in the long haul is not the plan, it is the execution. We have clients for whom we have helped make very detailed plans and they have pretty much executed those plans precisely. We also have clients who have never planned a thing in their life, but they live well within their means and have invested prudently and are financially secure. Just this past month I met – virtually of course – with a client who has been planning to retire in three years for at least five if not seven years now. Guess what she said when we talked? “I think I’ll work just three more years.”
The idea that success or failure is based on planning is just false. Success or failure will be based on our actual actions. For financial purposes, the first action is living within one’s means. One must form the habit of spending less than she makes, period. A plan can be helpful to calculate the degree to which one must save, and it can provide many people with needed motivation; however, at the end of the day it boils down to the habit of relative frugality.
Another line that comes from the insurance industry is that you must pay yourself first. I have known people who planned and then couldn’t do this, and I have known people who did not plan and did this still. The plan is not the magic.
Once one has begun saving money, he then needs to invest that money. Here again, planning can be helpful. A plan can show what rate of return is necessary to accomplish the goal, and that gives some guidance in how to invest. However, ultimately investing success comes from the habit of prudent investing. Prudent investing has three attributes. First, it is always done from the bottom-up. Each investment must be analyzed and judged on its own merits. Secondly, it is absolute return-oriented. In other words, the investor is not making decisions to compete with another investor or an index, but based on her actual long-term goals and needs. Finally, it is risk-averse. There is no glory in taking risk for the sake of risk.
This is where the planning community goes off the rails. The vast majority of people who refer to themselves as financial planners have no background in how to actually build a portfolio to achieve a certain goal. The planners came from product sales and to this day remain in that mindset. Some have departed from the commission-based life and that is certainly a good start, but as the saying goes, “putting kittens in the oven doesn’t make them biscuits.”
Going fee-only is a good thing. Conflicts of interest should be avoided at all costs, and moving away from the traditional commission-based sales approach in the financial world is the right thing to do, but it doesn’t then qualify a person to actually build a portfolio. The real issue with financial planning is that its practitioners spend all their time learning how to plan, and little – if any – time learning how to execute a plan.
This brings us back to ole Fluffy Watts. “Coaches don’t win games, players win games.” There is a cliché I imagine Fluffy would agree with. Coaches can certainly make players better, but their role is to teach and guide. John Wooden thought of himself as a teacher. Dean Smith came from a family of teachers. Show me a coach that has a consistently winning team and I’ll show you a coach who is great at making players better. The players win the games.
I know myself from the years I have spent in youth coaching, that I did not win a single game. Some games I believe I helped on the margin, and those were the good coaching days. Most games I had either no impact or worse I hurt my team. The players won the games. I could plan all I wanted, but ultimately it was up to the players to execute.
No one plans to fail; they fail to develop the good financial habits that lead to success. We are all different as individuals. Some need to plan in order to instill those habits, while others go with the flow. Regardless, it is the execution that matters. John Wooden published a poem of an unknown author. It is a story of a parent speaking to their child before the first game. There is a line in that poem that says, “But winning is not the point, Wanting to win is the point.” When I read that poem it was the first time in my life that the other cliché finally made sense to me. Winning and losing a game doesn’t matter because it is so often out of our control – a ball bounces the wrong way, the ref makes a bad call, the other team makes some miracle play. We only control how we play the game, and we play to win. We execute.
There are many things that we cannot control that can impact our plans, but we can develop those good habits, and if we do so we will be successful, plan or no plan.
Chuck Osborne, CFA
~Failing to Plan, and Other Nonsense People Say
On March 17 of this year, I explained in a client meeting that the market was in the process of bottoming, and the client asked how I could possibly say that. The COVID- 19 crisis was raging with no clear end in sight, the economy was shut down, and the unemployment rolls were filling faster than in any time in history. How could I possibly be thinking that the market was bottoming?
The market, as it turned out, was indeed bottoming then and hit the very bottom just four trading days later. How did I know? After doing this for 28 years, I understand that investing is part rational science and part art.
The science of investing we talk about a lot: analyzing companies from the bottom-up and estimating their actual value; comparing that value to the current market price; asking questions like, What is this company’s competitive advantage? What is the potential for growth? These things can be quantified and put into a model.
The art? That is a different story. The art is about judging where investors are in the cycle of market psychology. It is emotion, not reason, that drives the market on a day-to-day basis. The longer one is in this profession, the better he gets at reading the emotions of the market, and by March 17 this year, the market was just about done with its downward emotional cycle.
One of the best descriptions I have ever heard about the emotions of the market came from a presentation at the 2012 CFA Institute Wealth Management Conference. A gentleman by the name of Greg Davies with Barclays gave a presentation entitled, “Utilizing Behavioral Finance in the Management of Client Portfolios.” Davies showed a chart that reflects the ups and downs of the market and the emotions investors feel at each stage.
The first step for most investors is reluctance. Making an investment takes a leap of faith; everything we can possibly know about any investment is in the past, and our results will be completely determined by what is in the future. The future is unknowable, and while we do everything in our power to put probabilities on our side, anything can happen tomorrow. This uncertainty makes investors reluctant, and when the market pundits start talking about uncertainty, that is a good sign that we are in the beginning of a bull market run.
As the market climbs, investors start to grow in optimism. Maybe their reluctance was misplaced. Events certainly seem better than expected, so confidence begins to grow. The market uptick starts to accelerate and people begin to believe that maybe the future isn’t so uncertain. Things look positive, at least from a market perspective.
This positivity grows until the optimism turns into excitement. The investors who were brave enough to overcome their reluctance are now bragging about their portfolio gains. The news is highlighting record highs for market indices. Everyone starts talking about their 401(k) and how they will be able to retire in two more years if this keeps up. The excitement is contagious. The wealth effect causes people to spend more out of their income, even though rationally their investment market values and their income are two separate items. The economy picks up because people are excited and spending money. Experts say things like, the market forecasts six months in advance and was telling us months ago about this wonderful economy. Those investors were not uncertain at all, they were “right” about this bull run.
Now the excitement becomes exuberance. Exuberance is actually closely related to reluctance; both are forms of fear. Our investor started out reluctant because she feared the unknown, now she fears missing out. All of her friends are making money hand over fist, and she now really needs to get in on this game. This is when the average lay investor finally gets into the market. This is when clients call us and say, “You know what, I think I should be taking more risk than I have been.” This is when experts start saying, “This time it is different. We know the future is bright.” This is the top.
Of course, once we are at the top, there is only one place to go. The market starts heading back down. The first reaction to the downward market is denial. We all know that investing wisely is a long-term activity. We are in it for the long haul, and this is just a market hiccup. There is nothing to worry about; in fact, this is a buying opportunity.
Yet, the market keeps dropping. The denial turns to fear. Could I lose everything? Will I still be able to retire? I know I am supposed to ride it out, but this is really scary. The future is once again uncertain, but I know this is what investing is like, so I’ll ride it out. Ride it right into desperation. I used to have a 401(k) but now it is a 201(k). I’ll never be able to retire. I’m just a really bad investor.
The desperation can go on for some time, or it can be really short-lived, but ultimately what follows is panic. This is when the client who called a few months ago wanting to increase his risk exposure all of a sudden wants to pull the plug. My portfolio is down X amount and we can never make that up. Now the anti-wealth effect hits and people stop spending, even though rationally their investment market value and their income are two separate items. The economy slows and the perma-bears who predicted this market downturn along with the last three and 20 others that didn’t happen (they usually fail to mention those) start talking about how the future is certain and it is bleak.
The lay investor can no longer take it; the capitulation has begun. There is a great washout, every last long-term holder of investments gives up, and the market crashes to new depths. This is the bottom. This is precisely the time the best investors start to buy, and buy aggressively. The market starts to rise, but we have been through an emotional roller coaster and we have landed in the territory of despondency. I have lost all that money. I can’t believe it, this is just horrible. It is all a big scam.
The despondency gives way to depression. The market is quietly ascending while people are still not spending money; the economy is horrible, the market is “disconnected from reality,” life is depressing, and the market is going to go down again. Except it doesn’t. It doesn’t drop in 2010 after the rally in 2009 and it doesn’t go back to the March 23 low today. It keeps climbing.
Apathy sets in: I was never going to retire anyway, it doesn’t matter. Apathy gives way to indifference: Oh, the market is up today, who cares? Just a bunch of Wall Street guys gaming the system, don’t they know how bad it is out here? But, as the market continues to rise, indifference finally gives way to reluctance, and we are back where we started. The lay investor does it all over again.
So, back to the original question: How did I know that the market was bottoming on March 17? First, I didn’t. I thought it was, but I have been doing this for 28 years. If you wanted to talk to me when I “knew” what the market was going to do, you would need to go back in time at least 26 years when I was still young and unaware of what I didn’t know. I thought we were bottoming because market activity looked like capitulation, and capitulation always marks the bottom.
I did not know it would be a v-shaped bottom; in fact that is not what I thought at the time. I thought we would bounce around the bottom a little longer, but I also knew that I could be wrong. We moved forward prudently, but with the idea that the bottom was either here or very near.
Today, I am fairly optimistic as far as the market goes. Why? Because I keep hearing pessimistic voices. I’m not sure exactly where we are on the emotional rollercoaster, but it is somewhere between despondency and reluctance. This gives me confidence.
Understanding the psychology of the market can be a great tool, especially when added to a scientific approach. Investing is part science and part art; it is not 100 percent either of those things, and do not let anyone convince you otherwise. Quantitative approaches that try to make it all science tend to do very well until they completely blow up, while those who think it is just an art and go with their gut tend to blow up even faster. Wise investors understand it is both.
This leads me to the final thought on the subject: Every investor is subject to this emotional rollercoaster. There is no immunity. Being a professional and having 28 years of experience does not make me immune; I feel these emotions just like everyone else. The difference is being aware of how one’s emotions are affecting him at the time. The two important ones are reluctance and denial.
We put various rules in place in our process to overcome reluctance and denial. If an investor can overcome reluctance, then she can take advantage of the sharpest assent in the market; this is very important for long term results. Likewise, if she can overcome denial, then she can be defensively positioned during the worse of the downturns; this allows her to be far more clear-headed while others are capitulating, creating great opportunities for those who can once again overcome their reluctance.
The cycle continues. This is not to say that everything remains the same, or that it isn’t different from time to time. The dot-com bubble cycle took place over at least six years, from 1997 through 2003. It was slow and drawn out. The bubble burst in March of 2000 and the bear market did not bottom until halfway through 2003. The financial crisis hit in early 2008 and bottomed in March of 2009. The COVID crisis went from denial to capitulation in a month. One cannot mark these cycles with a calendar, but in each case, the downturn starts with denial and ends with capitulation.
I understand the human desire for everything to make sense. We want logical explanations. Every day the pundits make up reasons for what the market did. The truth is that the market is made up of people, and people are emotional, not rational. Understanding what those emotions are and how to recognize them helps investors flow with the market cycle instead of trying to fight it. That is the art of investing.
Chuck Osborne, CFA
~The Psychology of Investing
I have struggled with what to say in this Quarterly Report. I have written almost every week since the crisis began, so there is not much new to report, yet it seems somehow inappropriate to discuss any topic other than the virus. Then, as I was leaving my office, one of the talking heads on CNBC said, “I’m scared to death of this virus, as I know we all are.” It happened so fast I failed to even register who said it, but it just hit me. Scared to death of the virus, as we all are.
It hit me because I am not afraid of the virus, and I do not believe I am alone. I am not saying that the virus shouldn’t be taken seriously, nor am I judging anyone who is afraid. I am just telling the truth. The virus does not frighten me. In the same way, sharks do not scare me. I grew up near the ocean, got certified to scuba dive while still in school. There is nothing in the ocean that “scares” me. There are many things, including the water itself which I treat with respect because I am aware of the potential danger, but I am not afraid of it. I am not going to stop swimming in the ocean.
During our first weekend of social distancing, my kids and I built some shelves for our garage. Our 12-year-old son made most of the cuts with a circular saw. This is a serious power tool. Was I afraid to let him use it? No. Did I go over the safety rules? Yes, including the need to be supervised. Our 9-year-old daughter did not use the saw, but she did drive in some screws with the drill. I was not afraid to have my kids around power tools. Am I aware of the potential danger? Of course, but that is not the same thing as fear.
Part of not being afraid comes from knowing how to stay safe in potentially dangerous situations. The most frequent question we have received from our clients during this crisis is, “How are you all doing?” That speaks volumes about the quality of our client base, so thank you. We are all well. I am still coming into the office, which is surreal because it is like a ghost town. Thomas Healy, one of our analysts and our primary trader, is also coming in as trading is much easier to accomplish in the office. Everyone else is working from home.
Would I be afraid of the virus if people were not taking the social distancing seriously? Perhaps, but for the most part, people are taking it seriously. Just like we know how to maximize our safety when enjoying nature or using power tools, we know how to maximize our safety from viruses. Wash your hands and keep them away from your face. We’ve all heard that. I’ll add some. Eat healthily and keep up with your vitamins C and D. Drink a lot of water, I mean a lot. Keep up your exercise, and hugely important for all health but majorly ignored: get enough sleep. Will that stop you from catching a virus? No, but the stronger and healthier you are, the more likely you’ll be able to fight it off if you do get it. How do I know this? More than 50 years of experience catching viruses. We all know this.
I know, I know, this virus is new, and it is serious. Yes, I’m still not frightened. What if I do get it? According to the data, there is a 50 percent chance I won’t even know it. I have no proof, but based on life experience, following a healthy lifestyle probably increases my odds of being in the 50 percent. There is an 84 percent chance my symptoms will be mild. I like those odds. “Experts” claim that between 1 to 3 percent will die. First, they are wrong. How do I know? They are always wrong. They said the same thing about the 2009 H1N1, and after it was all over the real mortality rate was 0.2 percent. Not that different from the common flu, which kills 0.1 percent of the people who get it. I am not a doctor, but I do crunch numbers for a living and I would wager we end up in the exact same territory with this virus.
What if, against all odds, the worst does happen? Sorry, I’m not afraid. That may seem like a false boast, but it is not. There are two reasons for this. First, I know we are never supposed to bring up religion or politics, but I am a man of faith. That gives me great comfort. Secondly, I have been there. Some of our longer-term clients know this, but for those who have not been reading these pages for a decade, I should already be dead. On May 15, 2010, my wife drove me to the emergency room. I had a pulmonary embolism, which is a fancy way of saying I had multiple blood clots in both lungs. The pulmonologist told me that 90 percent of the blood flow between my heart and lungs was blocked.
I spent ten days in the hospital, five days in the ICU. During that time, I kept getting the same stupid question. The doctors kept asking, “You walked in here?” Yes, I did.
I had been suffering from shortness of breath for a month and had been to the doctor’s office three times about it. My wife finally took me to the emergency room because I was getting a strange feeling down both arms. The cardiologist said that I did not have a heart attack, but my heart was, “a little ticked off.”
Every time they asked that stupid question I also got the look; the look that said, “You should be dead.” Throughout that ordeal, for whatever reason, I was never afraid. There was one moment when I saw the urgency in which the ER personnel responded to the description of my symptoms that the seriousness of the situation hit me. My wife was parking. She was pregnant with our daughter and our son was two and a half years old. I wanted the staff to wait for her, but they refused and assured me they would send her back. That was the darkest moment and I had one thought. I prayed, “God, my kids need their father.”
I was not scared of dying, I was scared of not being there for my kids. (Sorry, Honey. I know it would have been more romantic if it had been my wife who came to mind, but I must tell the truth.) The point is that it was not death that I was afraid of, it was being out of relationship with those I love. Life is not about the avoidance of death, it is about being in relationship with one another.
This virus does not frighten me, but there are some things that do. It scares me when people talk about this being the “new normal.” I believe they are just remembering that phrase from the financial crisis. Economists described the slower growth rates following the crisis as the new normal. It was a debatable phrase then, but now it is downright horrifying. We may need to socially distance for a while to flatten the curve, but cowering in isolation is not a permanent strategy. This cannot be normal. We cannot allow this to become normal.
Relationship is too important. That is what we do here at Iron Capital. Yes, we provide investment counsel, but that is just our chosen field. We really deal with relationships. The last in-person client meeting I had before the lockdown was in Chicago. We greeted each other with a hug. I don’t hug every client and I assume the two ladies in question don’t hug every vendor. We hugged because, after 15 years of working together, having lunches together hearing about each other’s children, etc., we sincerely care for one another. That client is in the hotel business, and they are in my prayers every night.
We invest in companies; we do not trade in stocks. Every client has heard me say that. Companies – or should I use the dirty word, corporations – are built on relationships. In fact, it is when large powerful companies forget the importance of relationship that they begin to fail. It is an easy thing to do. Show me a company that is good with relationship and I’ll show you a good business, led by a good businessperson.
My wife has diligently packed more food into our house than it has ever held before, and after she did, I told her we were ordering from a local restaurant. Why? Because we care about the people who run the places we love. Economic activity is not some dirty word, it is proof of life. It is relationship.
Which brings me to the silver lining in this dark cloud. A few evenings ago, the four of us walked our two dogs together. Father, mother, son, and daughter out with the family dogs. Norman Rockwell would have loved it, and as many of you probably suspect, we were not alone. Our neighbors were doing the same. We all made a joke of staying the appropriate distance apart as we passed on the street. One of our older neighbors said, “I love this, it is like the ’50s… all the families together.” Relationship.
This too shall pass, and hopefully, it does not become the new normal. We may, however, learn that the late night in the office should be the rare exception, and perhaps our kids can survive with fewer activities. No one likes a crisis and we cannot wait for this one to be over, but they do remind us of what is truly important. It has been a decade since God spared my life, and seldom does a day go by when I don’t think of the dying words of Captain Miller, Tom Hank’s character in Saving Private Ryan, “James, earn this. Earn it.” Captain Miller had lost most of his men working to find and save James Ryan. What scares me? Not earning it scares me. Not caring for the relationships whose importance is highlighted in times of crisis.
For Iron Capital, that relationship is with you our clients. That is what guides us through this crisis and will continue to guide us. Relationship is what it is all about. I hope and pray we continue to earn it.
Chuck Osborne, CFA