Beyond The Headlines
What to do when nothing works?
I recently had the pleasure of delivering a TEDx Talk to a wonderful audience of bright young minds in California. My subject was “The Great Investor in You.” During the following book signing many attendees approached me with various thoughtful questions and comments, but one really stuck with me: “How do you invest,” a student asked, “when nothing works?” It’s such a good question that it deserves a longer answer than I could give that student on that day.
See what works, and what doesn’t
This query reminded me of a story I came across years ago. A widow was put in charge of a family business operation after her husband’s unexpected death. The employees, concerned about the firm’s future, were looking for direction. Despite the widow’s previously limited interest in the company, she came up with a good first step by asking everyone to list which of their business practices worked, and which didn’t. After that, her instructions were simple: do more of what works and less of what doesn’t.
(If only decision-making was that easy in investing, we’d all be swimming in riches!)
What doesn’t work, then?
Until the beginning of 2018, investors could have believed that everything (or anything!) in our field worked, especially if your definition of “working” is that whatever security you buy, it goes up. We at Sicart watched the market with great curiosity and growing caution. Almost anything we bought (or even looked at) increased in price. Even some truly unexciting corporate bonds were showing appreciation that nicely supplemented their meager yields. Volatility disappeared and every market seemed to be on autopilot, heading skyward.
Since the early days of February, though, we have experienced some truly volatile periods. Even now the charts of major indices look “broken” as someone described it recently. They definitely don’t point straight to the sky anymore. Maybe just buying almost anything and hanging onto it for a few months is no longer a valid strategy.
Momentum & growth
There are many wonderful tools these days that allow us to look back and see which factors (growth, valuation, profitability etc.) were operative in periods ranging from the prior month to the prior year. We have noticed how anything to do with growth and momentum in price or sales has dominated the top of rankings. The easiest way to outperform the broader market was to buy the strongest performers by those standards.
But that clear-cut approach may not have been as successful in the choppy market of the last few months. Fewer companies show unbreakable momentum, and the winners of the last few years seemed to have flat-lined for now.
The term “value investing” means different things to different people. Some believe it’s buying stocks at a low multiple. Others, using a broader definition, think it means buying stocks for less than they are worth. The value investing crowd has been under a lot of pressure in this ever-rising market. How does a bargain shopper succeed in a market where expensive stocks only get pricier?
The peculiarity of the year-to-date market volatility and weaker performance didn’t leave “value stocks” unharmed. Interestingly enough, many low multiple/high dividend stocks have struggled more than the market darlings. Many investors hoped to see growth stocks give up their gains quicker than the traditional value stocks, which haven’t even kept up with the rally of the last few years.
If momentum is not an obvious choice of strategy, and traditional value hasn’t proved its merit in this market, the whole idea of active investing is being questioned more than ever. We have seen many prominent hedge fund managers throw in the towel in the last few years, and passive index investing has never been more popular.
As investment advisors, we are concerned that passive investing works beautifully in fool-proof markets where prices consistently rise. However, it disappoints dramatically when things turn, and the choices made by active investors start to matter. What choices do we have, though?
Back to basics
We have the privilege of working with entrepreneurs and multi-generational families. Their fortunes have an unusually long investment horizon. In fact, as a friend reminded me recently, the investment horizon of a family fortune is infinite.
This brings us back to the wise widow leading her family businesses with an investigation of what works and what doesn’t and doing only what works.
This strategy works in investing, but only if we know what time horizon we have in mind. Since nothing seems to work in the current sideways market, we suggest extending the investment horizon to 5-10 years or more.
Over our years in business, we have learned that over the true long run, it’s not the hottest stock- of-the-month approach that works best, but rather old-fashioned, disciplined, patient bargain- shopping for quality businesses. If we can consistently pay much less than we get in value and we hold our investments for a long-time, possibly forever, we just can’t go wrong — though we will not win every beauty contest on the way.
The earlier mentioned factor rankings, but with an extended investment horizon to 7-15 years rank the trusted value investors yardstick: price-to-earning as the best predictor of a stock’s outperformance over the long run. Although few of today’s investors care to look beyond a month or two, we are happy to be among those who do. A long-term horizon takes the pressure off investors to figure out “what works” in shorter periods of time and focus on what works in the long run.
And what really works, time after time, is buying securities for less than they are worth. The bigger the gap between the price and value, the better!