Monday, July 5, 2010

The Declaration of Independence
and Your Investments

Introspection is not one of the listed activities for usual July 4th celebrations though perhaps it should be, at least this year, in terms of your investments. Let’s start with the Declaration itself. The assertion of independence, among other elements, was to sever dependence on Great Britain with its laws and its world dominating Navy and Army. In the future these United States would be governed by our own laws and natural, perhaps God given, principles. In a much less dramatic way, the recent reactions to the global financial problems are similar to the yearning for freedom which was sweeping the world in the 18th century.

Changes going forward

There is a good chance that going forward the investment world will be as different as were the changes in the political world as a result of the first successful revolution to create a new country. In a small way the enactments of the “Dodd-Frank Wall Street Reform and Consumer Protection Act,” “Obamacare,” and the European and the Chinese austerity programs plus the investor reactions to these moves will change the investment world going forward in a similar way as did the American Revolution.

Two important aspects of the Declaration

There are two aspects of the Declaration of Independence which do not get enough attention. The first is the framers belief in “natural law.” They recognized the limitations of appropriate government authority. They looked primarily to our citizens to follow the recognized natural law of seeking the pursuit of happiness among other rights. Putting this natural law into perspective today, we need to recognize how people operate within markets not only for securities but also for a full array of goods and services. There will always be more and less popular items. The congregation of popularity can be handled in most markets. When popularity becomes extreme, the market structure will force a higher or lower price. As prices gyrate so does the temptation to take advantage of driven transactors. There are other natural laws, e.g. nine women can’t have a baby in one month.

The second aspect the Declaration I would like to emphasize is the 56 signers. They were all risk takers, not just 11 merchants but also the 24 lawyers or judges. They paid for taking the risk of rebelling against the most powerful nation in the world. Five of the signers were captured, tortured and killed as traitors. Twelve had their homes ransacked and burned. A number died destitute or bankrupt.

The important things to remember from our founding are that from the beginning we were risk takers and we would look to new laws. As a group we are used to unimaginable changes. (I believe this attitude should be incorporated in our portfolio thinking.)


However, the saga of the Declaration shows we are only willing to move ahead so far until proverbially, we kick the can down the road. In today’s terms, the issue that our Founders could not settle was an entitlement. We properly recognize it as slavery. For many it was a moral issue and for others an economic entitlement. With the coming austerity programs, I believe we are on a collision course with entitlements. Just as the issue of slavery in the US was settled with much loss of life in the Civil War (unlike the UK, where the issue was settled bloodlessly), I fear there will be high social costs to a cutback in entitlements. Some of these costs will be borne by investors.

Portfolio implications

With all of this as background, what should we do to prepare our portfolios for the post revolutionary phase? I would suggest the following as a general outline that needs to be adjusted for each investment account:

  1. A large liquid tactical reserve.
  2. Equities of companies that can adapt to change.
  3. Investments in countries of savers who also have rising productivity.
  4. I would avoid those “go anywhere” funds, not that the concept is faulty. The practice unfortunately is that these portfolio managers go back to the securities they are accustomed to. Very few of them learn new things.

Please share with me how you are preparing for the post regulatory revolution.

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