Introduction
Every moment of every
trading day we are confronted with the question, “Do we buy, or sell, or just
rearrange?” While one does not know exactly when the next major investment peak
or bottom will be, almost all of my time should be spent on how to function between
these extremes. Nonetheless, since the actual future turning points are not
known, I probably should not expend a great deal of intellectual energy or emotion
focusing on the search. If I have this discipline it puts me in a minority of
those who make statements about the market. Perhaps my investment accounts and I are
benefiting from this redirection of my emotion and mindset.
Nevertheless, most of us operate in a relative performance world, my
performance will be judged as how it compares with how others perform. Thus, I
need to grasp how other investors, particularly institutional investors, view
the market. As Hylton Phillips-Page, our firm’s VP of fund selection and I have
frequent discussions with both mutual fund portfolio managers and some of their
investors, I am struck that most of these chats revolve around “the market” in general, or the price of a
particular stock is expressed as a ratio of the current price to some other
variable. Most of the time the managers believe they are buying and owning at
some attractive discount to the larger variable. In other words they have a
model which is generating a distinct benefit for their investors.
Experience
as The Model
What I have learned from
the Neuro-economics professors at Caltech, (where I serve as a senior trustee)
is that when most are forced to make a judgment, the brain reviews its
experiences. If the experiences generated pleasure it was good and thus similar
situations will also be judged as good. Having been essentially a student of
investing not only through my life but also of others over history where I can
get some historical insight, I see a particular pattern emerging.
Most of the time prices
move gradually. Often at the final run up or collapse one can divide
professional investors/traders in general by age categories. Whatever driving
enthusiasm is largely supported by the young, who view the then current
offering as new, different, and wonderful will be the opposite of their
older brethren that distrust the surge as it looks suspiciously like past
problem-producing situations. Thus the more experienced players don’t
participate until the parabolic price move that comes just before the turning
point. Some of the more experienced players can’t stand missing out these
“goodies” and need to defend themselves against the arrogance of the newly
rich. (The same pattern occurs on accelerating declines to a bottom when the
twin views that the world is coming to an end and/or prices fail to reflect the
survival realities.)
I have noticed
throughout my career that many formerly successful investors miss out on “the
new thing” because the load of their experiences reminds them of past failures
from over-excited enthusiasm. One of the advantages of investing through medium
to large mutual fund management groups is that they often have bright analysts
and portfolio managers, some with a great deal of successful experience and often,
younger ones that perceive greater futures. In assembling a portfolio of mutual
funds we choose some of each.
Which
Past is Relevant?
To choose as the statistical
base for a predictive model we have recorded human history, derived history
from scientific sources in addition to yesterday’s news. I suspect we could do far worse
than being guided by The Bible. It tells of seven fat years followed by seven
learn years, currency manipulation by rulers, collectible and uncollectible
taxes, famines, wars, disease, population growth and immigration, etc. While no
one has proven that these lessons are not still applicable, we have chosen to
shift to statistical measures. Most often we rely on government produced
statistics. Since I have met some of the tabulators and understand how they
gather data, I have always had a
jaundiced eye on their product. That is even before today’s fully expected (by
me) article in the New York
Times about groups of government employees developing “slow
walking” strategies showing their opposition to the new Administration.
We measure our deficit,
that will undoubtedly grow, as a % of our GDP which is an output measure not a
wealth measure. As a matter of fact the government’s main view of the
population is derived largely from aggregating tax returns. I ask how many of
our readers attempt to show the largest income and the least expenses?!
Further, often as people get older their wealth grows and in retirement it is
their wealth not their income that motivates them.
Another source of
questionable value is reported earnings of public companies. When evaluating a
possible acquisition of a public company the excess assets and the operating
business are separately evaluated. (I sold a data business’s operating
assets, not the company and its balance sheet.)
One of the more popular
valuation metrics is averaging the last ten year’s reported earnings. This is
in contrast to my first lesson from Professor David Dodd, of Graham & Dodd,
which was to restructure both the balance sheet and income statement to put
them on a comparable basis with other companies that could have been investment
candidates. Many models are based on industrial sectors as defined by either
the government or a major credit rater. Over the years both IBM and Apple*
among others have been shifted from sector to sector. I suggest that if one
wishes to be long or short either of these securities, it will not be because
of different statistical ratios with whatever industrial sector someone places
them.
*Held personally.
We
are in a New World
I am well aware the
typical reason given to buy a security that is historically over-priced is,
according to the salesperson, “This time is different.” To some extent that
could be right today in that we have entered essentially a new phase. In the
past the leading countries were growing in population and wealth. Often they
were clearly technological leaders. In the United States, China, Japan, and developed
Europe, the size of the work force is declining relative to their total populations and all are
experiencing growth in seniors. (This may inhibit the new Administration’s
ability to grow the US labor participation.)
Interesting that some
have looked askance of my announcing our firm’s
smallest new commitment to a fund that invests in the Middle East and
Africa, because of favorable demographics, savings rates, and progress in their
educational institutions. Based on current trends it is only a matter of time
that Africa will house one quarter of the world’s population.
We are now living in a
world where farming and manufacturing are becoming smaller relative to the
growth of the service sector. (Service sector includes financial services which
is experiencing growth from traditional sources but also new entrants and
technologies. Unschooled farmers in Africa are daily monitoring the price of
their commodities on cell phones. The fastest growth in the financial sector is
in mobile finance and banking.)
The world is facing the
integration of currencies, taxes, trade and military policies. One should
expect that in the future we will understand the difference between schooling
and useful education.
Do
I Have a Model?
The simple answer is
no. But I have a process to benefit and protect my investment responsibilities.
First, I attempt to get our accounts to utilize the TIMEPSAN L Portfolio®
approach which addresses the importance of getting the future right. The
shorter term portfolios live in the world of the present whereas the longer
term portfolios are more future oriented. Since we use funds from a number of
the leading investment organizations each has their own views of the future, they
will change over time.
My model essentially
leans on the investment lessons that have been learned over the millennia and
watching what smart commercial and investment professionals do with their
long-term money.
Question
of the Week (or perhaps the year): What Model
Drives Your Investments?
__________
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A. Michael Lipper, C.F.A.,
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