Altus Insight - September, 2015
The Altus Insight
Market news, commentary and relevant topics for today’s alternative asset investor
Date: September 30, 2015
FR: Forrest Jinks
RE: I think I think…
Thinking can get a person in trouble, but it also is also vital for anyone trying to build an investment portfolio or business that will outperform the general “market”. It isn’t just first level thinking; reacting to events or news in a vacuum, but rather a higher level thinking that takes the effect of that news, event, or other players in the market place as additional input into the database of knowledge. Howard Marks and Ben Hunt (among others) communicate this idea far more eloquently than I and are examples of investors who have put higher level thinking into action to produce excellent long term returns. The downside of pursuing this higher level of understanding means consistently questioning what we think. Even if we were correct in our thinking last week, we may not be next week, and only by being consistent in our examinations can we stay current with the ever changing investment and business environment. This leaves me sometimes having things I think I think…
I think I think…The idea of Narratives being the driving force in politics, investing, and to a certain degree even economics, may be more powerful than I previously contemplated. I am likely to view more and more events through this lens going forward.
I think I think…I was too hard on Donald Trump last month. Not because anything I wrote was wrong, I still have confidence in the content, but because I singled him out as an example when his inaccuracies in trying to control the Narrative are no different than the President using a glacier in Alaska that science shows has been melting for over 200 years as an example of the effects of global warming, or any slew of other examples. Maybe The Donald brings more criticism upon himself because of his bombastic nature, but his insulting and worthless personal attacks aside he is trying to control the conversation just like the rest of the field. As was pointed out to me, his inclusion in the presidential field to date has provided us with someone willing to say things others are afraid to say and has uncovered thoughts and emotions of a wide swath of the electorate that people either didn’t know existed or were unwilling to admit existed. The press and politicians consistently craft a Narrative pertaining to events that probably aren’t that important, likely to avoid showing a lack of plan about the important things. As an example a PEW Research Centre poll from this spring (of over 45,000 people) found that US, European, and Japan (Japan?) citizens were more worried about ISIS than Iranian nuclear capacities, Russian or Chinese territorial expansions, Climate Change, OR economic instability. Meanwhile, in both Brazil and Argentina, where the economies and faith in integrity in government are plummeting, the most important issue was climate change. By the way, other than in the US, Europe, and Japan (Japan? Seriously?), the ONLY other place in the world where ISIS was ranked as the most important issue was in and around Jordan, which is pretty understandable. So long as the politicians control the Narrative the population can be kept from focusing on what may not be working so well elsewhere. Trump, through his Narrative, has been able to change the focus. With that, underlying dissatisfactions are being brought to light.
As Trump begins his (assumed) fall fade, the lesson I am left with is a large majority of the population feels the United States is losing its competitiveness and its greatness. Hence the power of his “Make America Great Again” message.
I think I think…They may be right. A recent Bloomberg poll reported that 72% of Americans feel America is losing its greatness. In a country more and more divided along two party partisanship, the fact that this large of a majority agreed on something gives it substantial weight. For years people have been concerned about the level of our education compared to other parts of the world (specifically Asia) but the economic freedoms and entrepreneurial spirit of the US made sure the country maintained its position as the leading economic player in the world, and in turn, that position as the economic player gave it the gravitas needed to be the dominant geo-political voice.
The American Dream allowed people across the world, even in countries hostile to the USA, to dream of a place where hard work could create a better life for themselves and their family. Even as the US economy has stabilized since 2008 there is mounting evidence of ongoing degradation of the pillars that made the USA great. A New York Times poll from earlier this year found that only 64% of the population believes the American Dream to be possible. Out of context this may not sound that bad, but it is the lowest result since the poll started decades ago and is an over 10% decline since 2009, during the heart of the recession when people had the greatest reason to be pessimistic.
Previous Altus Insights have already referenced that in 2014, for the first time in our country’s history, more businesses died than were started. The latest economic freedom study by the Frasier Institute ranks the US only 16th in the world in economic freedom, behind countries that would surprise many such as Georgia, Qatar, Jordan and United Arab Emirates. Just behind the USA? Romania and Armenia. Like the poll on the American Dream, context is needed to understand why a ranking of 16 would be causing me to wring my hands. 1st of all, when you have been the greatest country in the world for decade after decade, a 16th place finish is disappointing. Secondly, and maybe even more telling, the USA was ranked at or near the top of the list as recently as 2010, only 5 years ago.
I don’t think I would receive much argument that the 5 year free fall down the rankings isn’t because the rest of the world suddenly got freer. It is because the USA became less so. Something I have harped on, and will continue to do so, is that reduced economic freedom and increased regulatory burden are not benefits to the population. They increase the buffer between those on the top and those trying to innovate new and better ways to provide goods and services. This isn’t a surprise of course. More and more people feel that we are being taken over by crony capitalism. Which leads me too…
I think I think…The worst possible presidential election would be between Jeb Bush and Hillary Clinton. First of all, we are supposed to be a democracy (even if we are structured as a republic) where part of the American Dream is any kid can grow up to be president. Love him or hate him, President Obama should be celebrated for showing this to be the case. Unfortunately there are many that feel his presidency is reason to run back to the political elite. We are not, and should not be, an aristocracy or oligarchy.
Second, and still important to us as investors, Jeb and Hillary are more in the pockets of Wall Street than any of the other candidates. I have and will continue to defend Wall Street’s right to make money, but I believe they should do it under the same rules and punishments as the rest of society. The last few administrations, though giving efforts of reform lip service (Narrative) have instead allowed Wall Street insiders to rewrite the laws under which they are governed. The destruction of local banks can largely be blamed on the Dodd Frank Act, and to the benefit of the large banks who are reaping their customers. According to Narrative this same Act was supposed to collar the big banks and benefit the masses. Riigghhtt. Like any good magician knows, the trick is to get your audience looking at something unrelated to the sleight of hand creating the so called magic. This is the Narrative of the political elite while they rail on Wall Street in their speeches and then accept millions of dollars from that same Wall Street in campaign contributions. Jeb and Hillary are the most aligned with Wall Street. Watch the actions, not the words (Narrative).
The several paragraphs above lead to this: As citizens we have opinions of what SHOULD happen but as investors we need to be aware of what is LIKELY to happen, even if contrary to what we feel should happen. Even as economic freedom, and thus competiveness decreases and by all appearances the marriage of the political elite and business elite grows tighter, investments should be made with those trends in mind. Likewise, in a period of decreasing regulation and a leveling of the playing field investment can more aggressively be made into innovative products and companies with the risk being focused on market acceptance versus the difficulty and burden of dealing with the regulatory burden and the vested status quo. You want to know which industries and companies are favored? Look at campaign contributions, subsidies and tax loopholes. The beneficiaries of government largess are the golden children du jour. This doesn’t mean investments aligned with crony capitalism will provide high returns of course, but there is an increased likelihood of stable returns. History has shown this to be true even in our own country. Such were the days of the late 60s and 70s.
I think I think…Hedge Funds deserve the abuse they are taking for their underperformance, but let me be clear, when I talk about underperformance and I am specifically referring to returns on a risk adjusted basis. An 8% return is not better or worse than a 12% return unless additional context is provided to make that determination. Thus, my piling onto the hedge fund industry isn’t specifically related to their returns. My criticism is that a long only hedge fund (a hedge fund that only buys stocks – 44% of all hedge funds) by definition CAN’T be a “hedge”. By definition a hedge is making an investment to reduce the risk of adverse price movements in an asset or class.
Also by definition, a hedge has a cost. Therefore, when markets are increasing a “hedged” fund can reasonably be expected to underperform the overall market due to the cost of their hedged positions. However, during a downturn, like what we’ve seen in August and September, hedged positions should outperform the broader market due the hedges in place. Alternative investment strategies, as standalone investments, also can’t be hedged, at least not without severe difficulty. I can’t buy puts on my position in a commercial building and instead have to structure investments in such a way to be able to remain profitable through or despite market volatility. Many of these structures have been discussed in previous Altus Insights. The different between companies like Altus Equity Group, or even mutual funds, or managed accounts, is that there is not the implicit claim of providing the hedge.
I think I think…College football polls are an excellent, simplified example of how the stock markets work. Going into their game on Saturday September 24th, Oregon was ranked #7 in the country while Michigan State was ranked #5. If they played on a neutral site and their rankings were accurate it would be expected that Michigan State would beat Oregon by only a few points in a competitive game. Being a college football expert you would also know that home field advantage is worth between 3 and 4 points (3.8 to be exact) to the team with the home field advantage. Thus, if Michigan State had home field advantage they would have to win by at least 3 points to show they were the better team and at least a few points more than to show they deserved a ranking 2 spots above Oregon. It turns out that Michigan State did have home field advantage and in fact did win by 3 points. This indicated that Michigan State and Oregon were equally talented teams and they should be ranked accordingly. Instead Michigan State moved up the rankings to #4 while Oregon fell to #12. Was Michigan State now 8 spots better by not even covering the home field advantage spread?
Based on the “perfect” information of that single game the new rankings were obviously incorrect. This is what happens in the stock market. The voters that determined the football rankings overreacted to a single piece of data (the score) without taking other relevant information into account. But the really important lesson here is - It doesn’t matter that the new rankings weren’t logical. Just like it doesn’t matter if a price move doesn’t make sense. No one reading this article is a large enough player to move the needle of stock prices by their actions.
This completes this month’s article journey where it started. Understanding what should happen isn’t enough. Understanding what is likely to happen based on human/political/economic/etc. factors may still not be enough, but it is at least one step closer and is the higher level thinking mentioned in the first paragraph. Understanding that markets behave like college football rankings leaves us with only a few options:
1. Sell on the dip i.e. a knee jerk reaction. This is what most investor do.
2. Get out of the stock market (or bond market, real estate market, etc.) altogether and bury your investment in your backyard.
3. Have enough discipline to ignore price fluctuations and cling to conviction about the long term value of the investment.
4. Buy the dip. This requires not only the discipline of #3 but the courage to go against all popular wisdom/knowledge. This is what Warren Buffett refers to as “Buy when there is blood in the streets.”
Altus Equity Group, LP