"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price"- Warren Buffett.
It is always helpful to focus on what a share actually represents- it is a claim on a stream of long term cash flows to which shareholders are entitled over time. Given that the price one pays has a strong relationship with future returns, (the higher price one pays, the lower the expected return will be), a method of valuing these cash-flows would seem a sensible starting point. The future being what it is, however, it is not an exact science. Whether it is by design or malice, analysts often get their projections badly wrong. One of the reasons may be to do with their methods of analysis, or more precisely their mindsets when doing said calculations.
“Wouldn't economics make a lot more sense if it were based on how people actually behave, instead of how they should behave?” ― Dan Ariely, Predictably Irrational: The Hidden Forces That Shape Our Decisions
Conventional Finance theory has long assumed that Investors/Consumers etc. are rational, risk-neutral wealth maximisers, but the experience of the Dot Com bubble, the mortgage bubble and so on has led many to question this premise. Thus was born the field of Behavioral Finance, which posited that people make irrational decisions in a large number of situations, partly due to hard-wired psychological impulses that we find difficult to control.…
Despite oceans of liquidity, zero (or sub-zero) interest rates and all the politician's exhortations, Companies appear unwilling to invest. Thus, despite the best efforts of Carney, Yellon, Abe and Draghi, the global economy continues to stagger along, with only stock markets showing signs of strength (and even here, it appears that Investors and Traders are fully invested - and absolutely terrified!) Uncertainty rules, with a myriad of "problems" ahead that could end the bull market in an instant ("could" is emphasized here, for good reason). But what is clear is the Reagan's "Trickle Down economics" has not happened, with the Gini Co-efficient (a measure of in…
Just as with Carlsberg, we don't do predictions at EBI, but if we did they would probably be the best in the World...
I am sure you have already had your fill of predictions for 2017, but just in case you haven't here are some more, but with a slight twist - these are the opposite of the consensus view, taken precisely because of that fact. Call it a control experiment - how right can one be simply by saying the opposite of the pundits? We shall check back in approximately 350 days...
2016 was a normal year in most senses - pundits got it wrong, as usual, but this time the magnitude of failure was spectacularly large: not just the puditocracy though. As the screenshot below shows the Bookies got it badly wrong too, and it cost them real money.
"Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one... Truth, when discovered, comes upon most of us like an intruder, and meets the intruder’s welcome... Nations, like individuals, cannot become desperate gamblers with impunity"
Charles MacKay, Extraordinary Popular Delusions and The Madness of Crowds, 1841
Since the victory of Donald Trump, (equity) markets have been on a tear: there appears to be nothing to stop them, as optimism abounds. But there are some strange reminders of a past era, one that didn't end well for Investors. Will history repeat - does it have to?
"This too shall pass" - medieval Persian poetical saying.
The Big Money (Sovereign Wealth Funds, Global Pension money etc.) invests primarily on the basis of Currency - they first select the currency they wish to invest in and THEN the asset class that they prefer, according to their risk tolerance... It is the ebb and flow of this gigantic amount of money that creates Capital Account surpluses and deficits, which in turn can move interest rates and thus currency values themselves, in a feedback loop. Global Capital moves to where they feel safest, and at times they all seem to agree on a preferred course of action - this may be one of those times.
"We have long felt that the only value of (stock) forecasters is to make fortune-tellers look good." Warren Buffett.
There are lots of predictions out there already for 2017. In order to have a fighting chance of being right, I will focus on 2016 and look at the events that shaped what turned out to be an "interesting" (in the "Chinese" sense of the word) year. In no particular chronological order, the "main events" appeared to wrong foot all and sundry - It was not a good year to be a pundit.
"People who think they know everything are a great annoyance to those of us who do". Isaac Asimov
We return to the subject of Oil. The recently agreed OPEC deal to freeze output has finally stopped the rot, pushing prices back up above the $50 per barrel level, to much relief all round (the Saudi's, Russia and US Shale producers all stand to benefit handsomely from this development - it may even allow Venezuela to survive another year!). The chart below shows the extent of the gains since the low point of January/February 2016. The question is now about its duration - can the deal stick, or will the cartel resume its policy of benign neglect, leading once again to over-production and falling prices.
"Price is what you pay. Value is what you get." - Warren Buffet.
[All returns are quoted in US Dollars, to avoid the currency effects of Brexit on Sterling returns. The basic premise, however, is not changed by the base currency choice as currencies tend to be correlated with the economic cycle, whereas the Value (and Size) premium is understood to be independent thereof. I have used the MSCI World Index, as a global equity proxy. Essentially the same situation pertains throughout the regions of the world and especially so in the UK].
"You expect me to talk Goldfinger?'
“No, Mr Bond, I expect you to die” Goldfinger, 1964.
[The events of Tuesday/Wednesday has necessitated a substantial re-write of this blog - once again, markets have been wrong-footed by a massive underestimation of public mood. If it reads as if I am gloating a bit, it is because I most definitely am].
Where's my boy @JebBush at? Clinton's and Bush's finally kicked out of politics. Phillip Taylor tweet 08.48 am. 09/11/16.
"They would not listen, they did not know howPerhaps they'll listen now."
Don McLean - Vincent
Before the result on Tuesday, I found the following screenshot - notice anything similar? …
"Bankers are just like everybody else - except richer. Ogden Nash (US Poet 1902-71).
(This post is going to be a little formula heavy. Sorry, I shall return to my usual inanity next week).
Since 2009 Central Bankers (via QE etc.) have created a situation whereby all asset prices now have more or less the same expected long-term returns, such that Investors are now indifferent between them. So, Investors have (as was intended), been forced to look for alternative strategies to improve their return outlook. Two such strategies have emerged: the "reach for yield", namely the buying of High Yield equities on the one hand, whilst others have focused on "Value", to wit, the purchase of assets that are relatively cheap compared to their respective alternatives. Both contain some assumption flaws, which we will look at in turn.
“Most people would sooner die than think; in fact, they do so.” ― Bertrand Russell (UK writer, historian).
Steve Forbes (of Forbes magazine fame) once said (apparently) that you make more selling advice than following it. "It's one of the things we count on in our business, along with the short memory of our readers". An article I recently read (in Forbes, ironically), suggests that this continues to be the case. It once again takes the line that there are alternatives to Indexing, and that Dividend investing is the answer. Let's look under the bonnet to see how it arrives at its conclusion.
"Historically, the claim of consensus has been the first refuge of scoundrels; it is a way to avoid debate by claiming that the matter is already settled" - Michael Crichton
Without much fanfare, last month the IMF announced that it would be including the Chinese Renminbi in its SDR (Special Drawing Rights) currency basket for the first time, in doing so adding a fifth currency to the mix. It is the confirmation of the rise to global status of the Chinese economy (and by extension, the rise of Chinese political power), and has been hailed by them as them arriving on the world stage.
As shown below, the SDR has been falling versus the US Dollar over the last 2-3 years, prior to the Renminbi's inclusion.
"Once a barrel of lit matches rolls into a field of dynamite sticks, you don’t try to predict which one will explode; you just get the heck out of there"- John Hussman (US Portfolio Manager).
Sterling's immolation has taken centre stage again this week, but behind the scenes, after a long lull, problems in Europe are starting to re-appear. Both political and economic issues, long avoided, have come home to roost, putting the prospect of full-scale crisis back on the agenda. Let us count the ways...
In the early hours of Friday morning, Sterling fell from $1.26 to $1.18 in five minutes. It had already fallen from $1.295 at the start of the week, as "Investors" (1) took fright at Theresa May's weekend comments about a "Hard Brexit", suggesting that we might actually leave the EU (Shock,horror). The post- mortem has already begun, but it likely that we will never find out the real reasons behind the fall; so conspiracy theories will no doubt fill the void, especially as, unlike the Swiss Franc crash on January 2015, there doesn't appear to be any "news" associated with last night's carnage.
The hypocrisy of some is that we like to think of ourselves as sophisticated and evolved, but we're still also driven by primal urges like greed and power- Michael Leunig (Australian Cartoonist and Poet).
[This posting serves as an adjunct to the latest Wendy Cook article, posted on Tuesday, regarding Structured CD's in the US. What follows is a more UK-centric version of same].
Last week an adviser asked me about a new Structured Product a client had shown him. My first reaction was to rubbish it. However, I felt duty-bound to delve deeper into it. What I found made me wonder whether I had under-reacted! What I want to show today is not only how bad these sorts of things are for Investors, but how these firms make money on them (at the investor's expense). Indeed, given access to these markets, investors could actually construct these products for themselves.
“Stocks have reached what looks like a permanently high plateau.” - Irving Fisher, (economist), 3 days before the 1929 market crash.
We have covered this subject before (here, and in our Quarterly Review of Q2 2015), but it is always worth returning to, as Investors appear unable to shake off the conviction that they can "beat" the market. Passive inflows (and Active outflows) suggest the tide is turning, but as all politicians feel obliged to say nowadays, there is still much to do. It is gratifying to know that the ranks of Index investors are rising (through EBI, but others too), and that we are no longer the geeks at the party that no-one wants to talk to.
“Blessed is he who expects nothing, for he shall never be disappointed.” ― Alexander Pope
[We have recently been asked to explain in more detail how we arrived at our Expected Rate of Return numbers used as our return assumptions. What follows is an attempt to rationalise the output numbers, in a way that can hopefully be understood as the basis for our investment philosophy].
Below is a copy of the latest ERR breakdown, (from our Turnkey Workbook), showing the sources of the Equity and Bond Risk Premium (ERP) we expect to achieve over time. We shall attempt to dis-aggregate them and look at the internal logic of the results.
The Bond premium has 3 constituent parts:
1) The Risk-Free Rate (RFR) - the interest payable on a risk-free investment.
2) A Maturity Premium - as the maturity of a bond rises, so does the risks associated with that investment.…