Introduction
Recently
I ran into an old friend at a cocktail party who is retired from being the
managing editor of a trade newspaper. He expressed concern as to his own
investments with the current volatility. I suggested that the time he should
have been worrying about risk was during the fourteen months ending in January,
after nine years of rising markets! He was much more comfortable with gradual
gains and no declines greater than 3%. I said he should have been worried about
risk when others were not, which is perhaps the best measure of the reciprocal
level of certainty that a large number of pundits proclaim.
You
never know about the future, but one can guess what you don’t know. While in
the US Marines as an officer, we were instructed when planning for an operation
to identify the essential elements of information (EEI). We quickly learned
that it was rare to have as much as 70% of the
EEI. Applying the same approach to handicapping at the racetrack, I was pleased
to find 60% of the EEI. I feel the same today when
selecting individual stocks and funds.
I
suggest that in each of our attempts to measure risk, the largest single risk
is the unknown and it rises when the pundits are more certain.
Is the Public
Smarter?
“Americans
Hold Off on Spending Extra Tax Dollars” was a page 2 headline in The Wall Street Journal on Friday. In addition, February was the third
month that overall retail sales were slightly off from prior months. Consumer
spending was up +0.2% compared to a rise in wages of +0.4%. This was not what
was expected. I cheered this announcement as it demonstrates consumers are
acting rationally. In the end, the article did point out that a number of
consumers were using their tax benefit dollars to reduce their high interest
loans. (Economists would label this as savings or deferred spending.)
Consumers
should be fearful of increased state and local taxes as well as increased fees
paid to government agencies, and for business sales/use taxes. They should be
saving and investing to reduce their growing retirement capital deficit. I
don’t know whether it has yet entered into the public’s psyche that there is a
chance that the purchase prices of their items will bear the costs mentioned
and possibly the impact of tariffs.
A Second
Example of Consumer Smarts
For
the last several years American investors have been net buyers of “non-domestic
equity funds.” I am guessing that these buyers are not largely the same fund
investors that have been redeeming older domestic equity funds. I believe the
redeemers are completing their expected retirement, estate building, and large
purchase needs. To the extent that older fund investors are adding foreign
stock investments, they are hedging their domestic equity funds. For a number
of years the US dollar has been weak compared with other currencies and
deservedly so. Despite foreign investors buying US securities for refuge, it
makes sense for US investors to invest overseas. Often there are lower
valuations in local markets, which makes sense when
considering they are also in less liquid markets. They are also unique
investments not found within US borders.
Traders
are also buying more overseas investments while redeeming domestic ones. Each
week my old firm, now a part of Thomson Reuters, measures the net flows of both
conventional mutual funds and Exchange Traded Funds and Exchange Traded Notes.
For the last week, ending on Wednesday, ETFs had net redemptions of $11.5
Billion in domestic equity vehicles while conventional mutual funds had $2.5
Billion. (Remember the assets of ETFs are much smaller than conventional mutual
funds.) It is worth noting that just two ETFs had combined net redemptions of
$10.6 Billion in S&P 500 invested portfolios. This suggests to me that the
redemptions came from a small group of trading desks and not the general
public.
The fallacy of
the “risk on/risk off” approach
The
financial media has gotten into the habit of describing
market movements as either “risk on” or “risk off.” This is simplistic but can
be a binary switch for a quantitative portfolio. It assumes that the investor
has identified the risks. Perhaps, this in and of itself is a big risk. Many can produce a roster of risks. Few can
weight them. Fewer still can set the time when their impact will be felt.
The
fallacy of the “risk on/ risk off” approach is that it is one directional. At
all times we should be looking at both the opportunity for risk and reward. In
this case those that invest in mutual funds have an advantage over those that
use only individual securities. Mutual funds have flows that many individual
investments don’t have. Flows drive buy and sell reactions which cause the
portfolio to change. (Often a fund in net redemption benefits from pruning the
least attractive current holdings and has an additional opportunity to switch
into new investments.)
Regardless
of how one’s portfolio is structured, you should always be looking to add
opportunity.
Quotes from Berkshire
Hathaway’s Annual Report*
While
Warren Buffet lays out their thinking about acquisitions of companies, the
principles can be applied to selected individual stocks.
- good returns on net tangible assets and a sensible price
- “We evaluate acquisitions on an all-equity basis.”
- “Betting on people can sometimes be more certain than betting on physical assets” (I would include shown financial assets.)
- Berkshire’s goal is to substantially increase the earnings of the non-insurance group through a large acquisition.
- Berkshire has suffered four short-term price declines of 59.1%, 37.1%, 48.9% and 50.7%.
- “An unsettled mind will not make good decisions.”
- “Charlie and I will focus on investments and capital allocation.”
Perhaps
the single most important clue to Berkshire Hathaway’s long-term thinking is
the following statement:
- “The Yahoo broadcast of the meetings and interviews will be translated simultaneously into Mandarin.”
*Held in client and personal portfolios
Question of the Week: What
are the risks to your portfolio that others don’t see?
__________
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A. Michael Lipper, CFA
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