However, it isn’t fair to say we only focus on the negatives, as that isn’t our only role as a money/risk manager. We understand risk is required to capture investment return. What we try to identify are worthwhile opportunities for an allowable amount of risk. In other words, I give my initial thoughts on how long I think the wait time will be if we all just show up unannounced, and after I notice all the downcast and sour faces turned my way, I walk things back and describe what a perfect scenario may look like.
As you may have noticed, things have gone well for the major stock markets for some time now. The first half of the year saw the S&P 500 increase 14.41% and the Dow Jones Industrial rise 12.73%. As is common though, the summertime has slowed down. This gives people time to think (or rather - to worry). And no one worries more than investors… except money managers. We worry when things are bad, and when things are good. That is definitely what the majority of the news has been about recently - everything and anything that could possibly go wrong to turn the market. Even though much of the worry has to do with things that might possibly happen one to two years into the future, it is still creating a lot of uncertainty. Markets and investors don’t like uncertainty, instead preferring the illusion that everything is known and orderly.
If you haven’t been able to tell from previous letters and conversations, I like being a father. One thing I’ve realized about myself as I reflect upon my fatherly duties is that I didn’t always look and listen to my Dad the way Carter looks and listens to me. Somewhere along the line, Carter, who is a lot like me, is going to stop adoring and doting on everything I say, and will instead view my opinions on par with dirt. So… I am frantically trying to get in as much as I can now while the teaching is good.
Last week, Carter and I were sitting on the front porch watching the kittens play, and I asked him if he could spot the bunny in the neighbor’s yard across the street. He looked and looked, but wasn’t able to see it until I pointed it out to him. The bunny was doing its immobile disappearing act. So I started to teach Carter about animal instinct, behavior, camouflage, survival, predator and prey, environmental threats… “You mean it stays real still so the kitties won’t see it Dad?” Well, yeah, I guess that is what I was telling him. He is a better student then I am a teacher.
Investors are like bunnies, especially bunnies that are together lunching on the same piece of grass. They munch along happily until something moves or makes a noise and then they all become immobile. Even if only one of the bunnies heard the noise or saw the possible threat, the other bunnies notice its behavior and all stop too. Even if one bunny heard it from another bunny three yards over that there might be something to be scared of, that’s enough to make all the bunnies stop eating and be on high alert. They will stay motionless until enough time has passed that a communal bunny sigh of relief is issued, and then they get back to eating. Or until one bunny gets spooks and darts off. Then it is pandemonium.
Investors watch the behavior of other investors, wait, and then all scatter when one gets spooked enough to start selling. That is a risk we must take when investing in the market. Money managers know it, and we always include it in our attempts to educate our clients. Our clients also know it, and they accept it when they begin the investment management process… but everyone still wants to join all the other bunnies in pandemonium after the first bunny scrams. It is who we are as bunnies… or rather, as people.
I want to share a few insights from my recent discussions and reviews with Dad. We talked about all the speculation in the news, and the possible and unknown future risks that were being forced on the financial news consumer. This can be infuriating because it forces a short-term mentality on investors, even though the sources claim to champion a long-term purview on investing.
Dad shared some teachings from the book Against the Gods, by Peter L. Bernstein. Bernstein was a legendary investment manager, but also a prolific author, educator, and lecturer on economics and investment management spanning 5 decades. Against the Gods is Mr. Bernstein’s very enjoyable book about “the story of Risk,” or how we have come to understand the entire idea of probabilistic planning and risk management. It is mostly story-telling and written so even “bad Dad teachers” can understand. What is most relatable to today’s situation is how laughable it is that the talking heads so innocently tell us how things are going to turn out… relating to inflation, treasury yields, or market levels even just one month forward. It is true that we have so much available data and data computational ability today. 100 years ago, a 10 year old with a cell phone would be deemed a prophet when it comes to predicting the weather. I believe the trait most necessary for the prognosticator and risk manager is humbleness. Although it is extremely lucrative to be right when you are telling the future, those instances are very far and in between.
An illuminating quote that Bernstein shares in his book drives this home. The quote is by Frank Knight. Knight was an unsavory person, but a brilliant economist from the 1920’s to ‘70s, and a champion of the idea of uncertainty:
[Any given] “instance” . . . is so entirely unique that there are no others or not a sufficient number to make it possible to tabulate enough like it to form a basis for any inference of value about any real probability in the case we are interested in. The same obviously applies to the most of conduct and not to business decisions alone.
It is irresponsible to act as if tomorrow will be the same as today, especially as a steward of someone’s savings. That is why we remind our clients (and ourselves!), Past performance is no guarantee of future results. However, it would be equally irresponsible to not learn from the past when making decisions, especially decisions for behavior, and even more so, decisions of behavior relating to the management of someone’s savings. The data exists, and it is one of our greatest tools for shaping our future behavior and future results, but that doesn’t mean it shouldn’t be used humbly.
Here’s another quote from Against the Gods, though this one by Bernstein from his chapter titled “The Measure of Our Ignorance”:
Until we can distinguish between an event that is truly random and an event that is the result of cause and effect, we will never know whether what we see is what we’ll get, nor how we got what we got. When we take a risk, we are betting on an outcome that will result from a decision we have made, though we do not know for certain what the outcome will be. The essence of risk management lies in maximizing the areas where we have some control over the outcome while minimizing the areas where we have absolutely no control over the outcome and the linkage between effect and cause is hidden from us.
Investing is based on the future. You don’t make money in the past. So, when you choose to invest in something you take what you know today and make a guess on how things will pan out in the future. You can make that guess look as “educational” as you want to, but everyone that invests is taking on risk based on an unknown future (my favorite definition of risk: more things can happen than will happen). Economic forecasting is the same… a very complex system that is driven by the behavior of billions of participants… ending with a guess about how the future will unfold.
But… you want to use historical data that puts you in the ballpark of a similar future possibility. In that I am a fundamental investment manager. GameStop does not have good current fundamentals. If we compare the historical data we have on GameStop to other companies with similar historical data, their similar future possibility would be bankruptcy. They have a product that isn’t serving its market as well as their competitors and are finding it extremely hard to make a profit. If I was to come up with a legitimate investment thesis for why you’d buy GME it is that I will “hopefully” be able to sell it to someone else later at a higher price. My thesis wouldn’t be that the company is going to turn it around and become extremely profitable.
The current global economy and market environment will always have possible problems, just as it will always have possible opportunities. We are still retaining a healthy cash reserve, partially to be prepared when the bunnies decide to scatter. That scenario could likely happen, but if it does I believe it will be more from an instinct to run blindly from the unknown than any current possible weakness. However, once the pandemonium dies down, investors will have appeased their fear and their need to run, and will again be looking for market opportunity.
I hope you are all having a wonderful summer. Our summertime phones have been fairly silent, so please reach out whenever, for any reason. We are always ready to hear how you are doing.