Month: September 2016

Lake Wobegon and Index Investing

One of the characteristics of humorist Garrison Keillor’s fictional town of Lake Wobegon is, all the children are above average. The joke is that by definition, average means that some are above and some are below. All of the children cannot be above average.

Let’s say the advocates of index investing (also called passive investing) inhabit a fictional town called Passivia, where their beliefs are the rule.

In Passivia, all the investors are below average. Nobody does better than average. If one appears to, it is marked down to luck. Furthermore, it is thought to be impossible for any human to do better than average because of innate flaws in human nature or other factors. Fortunately, the advocates say, it is possible to nail average performance by following their plan. And since all investors are below average, this is an improvement for everyone.

Just as all the children in Lake Wobegon cannot be above average, all of the investors in Passivia cannot possibly be below average. It is a joke that almost nobody gets. Some investors necessarily do better than average and some do worse—just like the children of Lake Wobegon.

In our shop, we believe that investors do considerable damage by joining stampedes in the markets. But somebody is on the other side of every transaction. One of our three fundamental principles is to avoid stampedes in the market.

We also believe it pays to try to find the best bargains, which are often found among the least popular companies or concepts. So while many may be chasing fads that already made investments too expensive, we are looking for bargains.

The third principle is to ‘own the orchard for the fruit crop.’ If we do so, we do not need to care what the neighbor would pay for the orchard, or whether his bid is higher or lower than the time before. By inoculating ourselves against reaction to short term price changes, we are better able to focus on long-term results.

We have no guarantees to offer, not even that we will be successful in applying our principles. But we believe the attempt to do so increases the potential that we will be above average over the long term. After all, some people have to be above average, by definition! If you have questions about how our philosophy applies to your situation, please write or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All indices are unmanaged and may not be invested into directly.

Slow Burn

We are now in the 7th year of economic expansion and recovery since the last recession. Many commentators insist that after such a long stretch, the next recession must surely be right around the corner. Of course, they’ve been insisting this for the past 7 years–remember the term “double dip”? The recovery didn’t make it a full year before people started predicting its demise, and now here we are seven years later.

Part of the longstanding skepticism surrounding this market cycle is grounded in the weak performance of this expansion. It’s been a long, slow recovery since the recession started in 2008. In a lot of people’s minds, those two things don’t go together. They think, “The recovery is going slowly, so it must not have enough fuel to keep going for very long.” There is a certain intuitive appeal to this way of thinking. We tend to see something moving quickly as having more momentum, so it would take longer to come to a stop.

The economy doesn’t really work in terms of “momentum”, though. Instead, market cycles tend to be driven by sentiment. In a normal expansion phase, optimism feeds into faster and faster growth, eventually creating a bubble. When the bubble finally pops at the height of its exuberance, values plummet and the economy is likely to plunge into recession.

You can think of it in terms of an out of control fire. The bigger it gets, the stronger it gets—but the faster it burns through its fuel. A raging conflagration will consume its fuel and die down to embers faster than a more contained fire.

In this analogy the current economic cycle has been a slow, cautious burn. The fire is burning away quietly but hasn’t really erupted into a general blaze—pessimism is widespread and we haven’t really seen the kind of manic stampede that marked the last days of the previous few expansions.

We never know how much fuel there is left for our “fire.” The expansion must eventually run itself down, but this may be a matter of months or days or years—we can’t be sure. However, we view the slow pace of recovery as an indicator that there may be a good bit of fuel yet untouched.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Scorecard: 1,000 to 2

The Savings & Loan Crisis of the late 1980’s resulted in over a thousand felony convictions of executives for wrongdoing, after a third of the institutions went broke. The FBI had a thousand agents on it, and the government was determined to find and punish thieves. The New York Times wrote extensively about this.

Thoughtful people all across the ideological spectrum are incensed that there have been only two felony convictions related to the 2007-2009 financial crisis. The recent crisis had a far greater impact on the economy, workers, families and retirees. Yet far less was done to investigate and prosecute the bad guys.

Naturally, many people of all political persuasions are concerned and upset. Corruption, incompetence, or both? No one knows. It clearly violates the social compact on which our society is based.

Now, get ready for another astonishing shock. In lieu of sending criminals to jail, various agencies of government have been soliciting multi-billion dollar settlements from the large banks. But whose money is this? Yours and mine—shareholders. It is as if the government is collecting ransom from thieves which they are paying from our pockets.

If you think we are being melodramatic, consider that the Justice Department recently asked Deutsche Bank for $14 billion to settle allegations of wrongdoing. This figure is more than two-thirds of the bank’s net worth, as measured by the value of its shares in the market. In our system, the presumption was that a company is owned by its shareholders. Now we find out that the government thinks it is entitled to more than half the net worth of this company—instead of doing its job and prosecuting wrongdoers.

In our opinion, the system worked better and more fairly when thieves went to prison and shareholders enjoyed the rights to their property without impairment by arbitrary government action. One of the worst aspects of this situation is how little attention it is getting; this article is intended to help rectify that. Please spread the word by sharing and linking and emailing your representatives.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Fruition, What a Wonderful Word!

We’re inspired by recent conversations with clients and friends whose plans, as they say, have come to fruition. Fruition—the realization or fulfillment of a plan or project—scarcely begins to describe the satisfaction and joy we’ve seen.

The recent retirees after downsizing to a maintenance-free home, going to art festivals instead of pulling weeds, having more dinners with their descendants, seeing more ball games… people going on that Alaska cruise or the tour of Italy… hobbies becoming true avocations. These are some of the plans we’ve seen come to fruition for people we are close to.

A wise person once said that a plan is a dream put into writing. We are in the business of trying to make the arithmetic work for people who would like to try to make their dreams come true. We’ve written before about the best way to retire and the point is, dreams are personal. What are you trying to do? Where do you want to wind up?

One of the privileges of long experience in our work is seeing the realization or fulfillment of plans made long ago. But life sometimes throws curve balls. So we’ve also seen adaptations and adjustments made by people who would have preferred to avoid the need for adjustments. Not everyone we love lives as long as we wished, health may be fleeting, and circumstances often present a mixed bag. The point is, sound plans usually put us in better shape to deal with the unanticipated.

Money is not the most important thing in the world. But it is also true that resources give us options we might otherwise not have. Wealth may free up our time, and time is what life is made of. Dreams and arithmetic working together may make the best things more likely. If you would like to discuss your dreams and plans in greater detail, please write or call.

Au Naturel

We’ve written before about our positions in natural resource sector companies. They were key to both our pain in 2015 and our pleasure in 2016.

Noted investor Jeremy Grantham of Grantham, Mayo & van Otterloo (GMO) recently published additional insights on this topic in a white paper. Three of his nine key points are worthy of special mention:

1. “Resource equities have not only protected against inflation historically, but have actually significantly increased purchasing power in most inflationary periods.” Regular readers know we believe that prospects for increasing inflation are under-appreciated in today’s markets. Although we have no guarantees that we are correct in this view, and past performance is no guarantee of future results, we may be very well-positioned for a rise in inflation.

2. “We believe the prices of many commodities will rise in the decades to come due to growing demand and the finite supply of cheap resources.” Low prices have curtailed future supplies; we know how this works.

3. “Despite all of this, investors generally don’t have much exposure to resource equities.” As eclectic contrarians, we are used to marching to a different drummer. This is certainly the case in 2016 with regard to our exposures in this sector. The unstated premise is that when the crowd decides to gain exposure, a lot of money may shift into the sector. Again, no guarantees.

We are watching economic, business and market trends closely to see how this all comes out. We enjoyed the analysis by Jeremy Grantham, even as we guard against the fallacy of believing he is a genius because he agrees with us. As always, please call or email if you would like to discuss your position.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Meet Your Partner, Mr. Market

Suppose that you owned a partnership interest in a business, and that your business partner was readily available any day to either buy out your half of the business or sell his half to you—as long as the price was right.

Suppose, though, that your partner suffered from erratic mood swings. He can quote you the price he’ll buy or sell for any time, but his appraisals are always colored by his current mood. When business is good he over-values the business and offers you the moon for your half of the business; when business is poor he becomes pessimistic and offers to sell you his share for pennies on the dollar.

This is a metaphor Warren Buffett uses in his shareholder letters to describe the stock market from the investor’s perspective, dubbing our hypothetical business partner “Mr. Market.” As a stock holder you have an ownership interest of a tiny slice in a business. There is a market to buy or sell shares of the business at almost any time. But the price the market may give you depends on investor moods.

According to Buffett, if you understand the value of a business it’s in your best interest to take advantage of Mr. Market’s mood swings to trade when his prices are at their most irrational. However, he also offers this warning:

“But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence.”

So when the market is in a frenzy of buying or selling, there may be opportunities to profitably take advantage of the stampede—but not to join it.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Stock investing involves risk including loss of principal. No strategy assures success or protects against loss.

We Know How This Works

In late summer 2015, the price of crude oil had fallen in half to around $50 per barrel¹. The oil industry had retrenched, cut budgets, and laid off people. Companies knew projects that would make a lot of money at $100 per barrel could bankrupt them at $50 per barrel.

We wrote then that low prices would boost demand and cut supply, planting the seeds of the next shortage and the return of high prices. Sure enough, sales of large vehicles and total miles driven are setting records and exploration for new oil has crashed.

No one knew how low prices would go—we never do. It was frustrating to invest too soon in the sector and watch our holdings shrink in value. The price of oil fell by half again! We stayed the course and kept buying perceived bargains. It is gratifying to ultimately get it right.

Now Bloomberg reports that new oil discoveries are at the lowest level since 1947. Supplies that should be coming on the market eight or ten years from now will not show up. Low prices are doing what they always do: choking off supply.

We can’t know the future. But we know how this works. If you have questions or comments about your situation or holdings, please email or call us.

¹_{Federal Reserve Bank of St. Louis, Federal Reserve Economic Data (FRED)}

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

What We Did at the Big Conference

We learned very big ideas.

The path to find happiness is in improving the lives of others. And in the 21st century, cheating is over: transparency through technology rewards authenticity and punishes phonies. But perfection is NOT required: the only way to make progress is to fail early, fail often, and fail forward. This is the way to unlock the uncharted treasures of human creativity and genius. Whatever we are doing, today everybody is a media company—at a cost of nearly nothing.

We learned there is more to those we admire than we realized.

Randi Zuckerburg has a lot more to offer than being the sister of the Facebook founder. She shared amazing insights about communicating with people, win-win thinking, and how creativity works.

Will Smith is as good at empathy and wisdom as he is at humor. A story from his childhood taught him that if you lay one perfect brick at a time, you end up building something you previously believed impossible.

LPL researchers widened our minds to the true meaning of potential. It is NOT that the tiny acorn grows into an oak tree. Rather, the acorn can sprout a mighty forest of oaks—many forests, even. We each have an impact on those around us, and those who follow after us.

LPL top execs demonstrated the vision and stewardship by which they earned their positions. Operating department heads told us about their key initiatives, showing they are locked on the future and working to make it better.

We did other things too.

Saw old friends in high places, and newer friends who are destined for high places, and many wonderful and interesting colleagues. Bought a drink for my 79 year old hero from Arkansas, a friend who shares my goal of working to age 92. Heard interesting presentations, and even tried to deliver one.

I love this business!

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

228Main

News and Views from 228 Main

Month: September 2016

Lake Wobegon and Index Investing

Like this:

Slow Burn

Like this:

Scorecard: 1,000 to 2

Like this:

Fruition, What a Wonderful Word!

Like this:

Au Naturel

Like this:

Meet Your Partner, Mr. Market

Like this:

We Know How This Works

Like this:

What We Did at the Big Conference

Like this:

Share this:

Like this:

Share this:

Like this:

Share this:

Like this:

Share this:

Like this:

Share this:

Like this:

Share this:

Like this:

Share this:

Like this:

Share this:

Like this: