Get Ready to Pay For the Price of Wisdom

Introduction

August is the time that many parents and grandparents send tuitions and other payments to institutions of supposedly higher learning. We do this with the hope that our children and grandchildren will learn useful life lessons. (We recognize that so-called life lessons as taught by ivory tower academics will quickly evaporate, leaving a residue of how to spot valuable lessons in the “real world”.) But our young are not the only ones who should be prepared to enter a period of intense learning where they will be challenged. I suggest that every investor in the world is about to enter such a phase, whether we like it or not.

In a recent well written interview with the leaders of an important private-equity firm that was coming back from some serious mistakes the following points were made:

          “We had great successes which led to great mistakes.”

          “Ultimately mistakes are a bridge to wisdom.”

We are rushing up to such a bridge. We need to recognize the bridge is a toll road. A payment will be extracted from us whether or not we want to get to the other side. Further, we probably won’t be able to turn around and return to an investment period characterized as complacent, at least on the surface.

Still, calm waters

For the sailors among us until Friday the stock markets looked to be becalmed. This was in spite of Ukraine, Gaza, and Iraq battles, and economic data being published that is contrary to many learned estimates. Most so-called experts have been expecting interest rates to rise. However, by Friday 15 and 30 year mortgages, plus jumbo mortgages and rates on car loans all declined on a week to week basis. Reinforcing a feeling that the banks while fighting for market share are anxious to make retail loans, the average rate for money market deposit accounts (MMDA) also fell a bit. Many investors also do not seem to be concerned about the slowdown of the engine of Europe that is Germany.

I believe their attitude is that this is entirely due to sanctions on Russian trade. This is a concern to me on two counts. First, I believe the slowdown is being caused by deteriorating business conditions on the Continent;  Italy is already in recession and France won’t be far behind. The second count is the parallel with the month in between the assassination of the Archduke Franz Ferdinand and the first declaration of war to begin WWI. For my non-history student readers, the declaration was by Austria against Serbia.

A number of my friends who are believers in the value of charts are as usual worried. They question whether the declines we already have seen are the early stages of a standard correction to the remarkable results we have experienced in the price performance of many stocks led by small caps in general and numerous social media and biotech stocks.

I suspect we will at some point, not of our choosing, be buffeted by violent winds that will drive us back on to land again or out to sea to be exposed to greater danger.

The ultimate “Head Feint”

For my readers not familiar with American professional football^*, when the teams line up on the scrimmage line some players move their heads in what they hope will either make the opposing team think they know where the play is going to go or cause an opponent prematurely jump the line and draw a penalty. The next move in stock and bond prices may very well be such a head feint that will get many investors expecting a move in one direction, when the more significant move is in the opposite direction.

^* I have served as an investment advisor to the National Football League and the NFL Players Association for the past 20 years.

As my regular subscribers have learned I am very concerned that we could be due to have a material decline, possibly of the 50% variety. Based on the past, I believe to get that terrible decline we will need to see a sharp price rise in enough securities beforehand to suck all or almost all of the sidelined cash.

Wise lessons 

Wise lessons for forthcoming markets:

1.  Assume that each of us individually, corporately and politically will make mistakes. The key is to recognize the mistakes quickly.

2.  As skilled traders we may want to ride the momentum, but as investors, we should practice investing against the headlines and pundits.

3.  Recalculate your spending reserves. In our time span portfolio approach I advocate determining the rate of expenditures over the next two years including the potential of some negative surprises. I believe the discipline of a spending rate determination should be based on current facts not an overall budget calculation and not a copy of last year’s spending.

4.  Most investors talk long-term, but recognize that investment committees, both formal and informal may change over a five year period. Thus the replenishment portfolio to recapitalize the operating fund should expect a significant decline in the market in the next five years. (Readers of these posts should understand that it is the tyranny of these changing investment committees that I focus most of my commentary.

5.  Those investment portfolios that can expect to meet institutional or family needs beyond five years but within the expected lifespan of the bulk of the investment committee should develop target prices of securities that would make them attractive. These can be the existing names or new ones. For those who have high confidence in their analytical skills, earnings per share, gross margins or return on invested capital or similar measures can be used as triggers rather than prices. Warren Buffett looks for periodic price slumps to buy at favorable prices as did Sir John Templeton.

6.  For those who are managing their own or institutional money to meet the needs of future generations, the changes in market structure which accompany major stock price declines and other disruptive events create opportunities to find new champions which can produce spectacular value. If a number of these can be bought in the dark days, losses should be relatively small as a percent of the overall portfolio and the winners could be very meaningful.

7.  Never stop learning and looking for wisdom without being defensive of what “we know” that can prove to be it is just not so.

 

Please share with me what lessons you have learned and particularly those that you have now discarded.

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