"If everybody is thinking alike, then somebody isn't thinking" George S. Patton
In our 2016 Forecast Event a few weeks back, we detailed reasons why investors might want to stay away from equities. Most of these reasons were short term psychological factors which might scare chartists, trend followers and those who pay close attention to market patterns. Those that do not look at other fundamental factors likely shifted chunks of portfolios to cash or bonds over the last few weeks. The lack of breadth in this market, the failure of the Santa Claus rally and the subsequent drop in the first week of January caused us to take some risk off the table in our portfolios. This definitely did not cause us enough concern to want to sell significant investments in good and great businesses at reasonable prices. The market looks like a bear but does not sound or act like a bear when you take more time for study.
Of course, Janet Yellen and the Federal Reserve are acting less accommodative than they have been in the recent past by raising rates in December. But markets typically have a couple of years of strong gains after the first round of interest rate increases.
Our Biggest Concern
China is the biggest wild card that causes concern. It is hard to know what is happening behind the curtain. Is Oz the almighty wizard crazy, sick or dying? It is hard to know with China. Much of China’s economy and markets were clearly in bubble territory. Now that bubble has burst, what happens next? Will what transpires look more like the tech bubble burst we saw in 2000? Will we see something that looks more like what happened in Japan after their bubble burst in the late 80s? Will we see a financial meltdown in China which extends to Europe and finally to the U.S.? Behavioral Finance tells us that most people will fall into the recallability trap where the most recent and stark memories are given the most attention.
Many may be concerned about the worst case scenario: a global financial meltdown. Our analysis leads us to believe that what is most likely to transpire will be more akin to the Asian Currency Crisis and subsequent fall of Long Term Capital Management in the late 1990s. We included a few slides about this in our blog a couple of weeks ago.
Reasons to Stay Invested
As we noted in our Forecast Event and again in our subsequent blog, stocks are exceptionally cheap compared to bonds from an historical perspective. The probability of recession in the U.S is still low as evidenced by a healthy yield curve, decent earnings and strong leading economic indicators. The “Over Index” looks more like a set of “Unders” than “Overs” at this point. Lastly, the developed world outside of the U.S. is undergoing aggressive fiscal stimulus which has proven to be a benefit to stock markets.
Whereas we feel we owned some good and great businesses at good reasonable prices at the beginning of the year, we currently feel many of these are now selling at great prices with valuations unlike we have seen since early 2009. As John Templeton was fond of saying, it is best to, “buy when others are despondently selling”.
Follow the “Smart Money”
Many insiders and CEOs of public companies obviously feel the same way. Just last week we saw Warren Buffett purchase another $37 million of his favorite oil refiner. We also saw Jamie Dimon purchase over $25 million of his bank's stock. Steve Wynn bought an additional $15 million of his casino company. It also seems the insiders of a well known bedding company purchased close to $50 million of company stock as well. CEOs in general have a better record with their purchases than any other class of investors when it comes to their company stock, followed closely by CFOs, other company insiders and lastly significant shareholders with a 10% or greater stake in the company. It’s hard to imagine anyone having a better grasp on a given company or industry than the one in charge.
We would rather be buying when the CEOs are buying and everyone else is selling than the other way around, especially when great businesses are selling at prices at valuations we have not seen in years. It is our fervent goal to be able to train our clients to think the same way, to overcome their biases and destructive instincts.
It’s Important to Have a Process
If you want to be in a position where you are moving your portfolio to cash or bonds occasionally, it is important to have a process for doing this. With our models we regularly re-balance semiannually and sometimes more often to increase or decrease our cash and bond position. Leading economic indicators, valuation / price trends, the yield curve and other factors determine the extent to which we shift towards or away from equities. We are unlikely to move entirely to cash and bonds again unless we encounter another scenario like late 2008, however.
How To Avoid Falling into Mr. Market’s Trap.
We feel the first step is determining what traps you are most likely to fall victim to. Below we have listed 12 of the most common Behavior Biases. We will be covering these in our upcoming Brain Games workshops.
Key Biases, Fallacies and Traps that Hurt Investors Include:
1) Herding 2) Over-Confidence 3) Loss Aversion
4) Availability Bias 5) Confirmation Bias 6) Anchoring
7) Familiarity Bias 8) Outcome Bias 9) Choice Paralysis
10) Procrastination 11) Optimism Bias 12) Endowment Effect
Learning which of these common behavioral biases and detrimental instincts you are susceptible to can greatly enhance your ability to plan for and overcome them.
If you have not assessed yourself for these pitfalls, we strongly encourage you to join us for our next Brain Games session.
Data as of 2/16/2016
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