Market Musings Blog

Tonight Britain has passed a referendum calling for the country to leave the Eurozone. It looks like US markets will open down severely tomorrow. The British pound is down about 10% against the dollar, and Asian markets are sinking fast. So no question about it: we’re in for a roller coaster ride for a while.

Aside from short term market reactions, why should US citizens care about Brexit? We posit a few reasons:

1. That the Brexit vote resulted in ‘leave’ and voter turnout was so strong, indicates that a revolution of sorts is under way. A rather large percentage of people are pretty tired of not feeling heard, all over the world. Policies will have to change, which will usher in even more uncertainty than we’ve already seen this decade.
2. The success of Brexit may have an effect on our own fast-approaching election, or at least policies we pursue around immigration, trade, and so forth.
3. After Brexit, it’s a certainty that we will see other European countries contriving their own versions of ‘exit’. How strange that a few years ago we all worried that Greece might be forced to leave (Grexit), and now we have a country that has chosen to leave.
4. Well, ok, we can’t resist mentioning – if you ever wanted to visit England, now’s the time. It’s going to be cheaper!

Consequences of these shifting policies will reverberate to returns over time. We can’t possibly predict even the direction of the impact yet. For the time being, we view the ‘leave’ vote as a shot at buying assets at cheaper prices.

Finally, if you want to know why Brexit was entirely predictable, pick up a copy of The Revenge of Geography, by Robert D. Kaplan (reviewed on our Resources page here). Uncanny!

The market has taken a turn lately. The ‘in crowd’ – those golden stocks of last year, including Netflix, Amazon, Google (okay, okay, “Alphabet”) – are flunking out. Despite fancy earnings at Netflix and Google (Amazon hasn’t reported yet), the stocks fell sharply during their reports. These high fliers are all down for the year. Facebook is – thus far – an exception, up a few points; it hasn’t reported yet either.

Meanwhile, industrial companies are pulling out all the stops, and have been for several quarters now, managing their way through a strong dollar, emerging markets disruptions, bond market sell-offs, slow economies, the crash in oil prices, increased regulation …. you get the picture. Their efforts are finally being rewarded. Earnings are not necessarily good yet, but the big downdrafts have ceased, or everyone has become used to the negative scenarios, and these stocks are trading up, rather than down, despite some disappointments. This is the juncture we were waiting for – when investors shift from ‘bad news is bad, and good news is bad’ to ‘bad news is good, and good news is good’. It’s a time when so-so results are viewed as ‘well, it’s not as bad as it could be’. Even the banks, which were pariahs just a week ago, seem cast with a rosy glow.

The nerds deserve a day in the sun, after last year’s beating.

There are three ways to generate extraordinary returns from stocks. You don’t need a degree in finance, or tons of experience to practice these methods. Like doing anything well, you do need diligence and discipline. Beyond that, time is the only necessary ingredient.

1. Follow and learn about a company that no one else follows, to gain an information advantage. Thousands of listed stocks are available, and 99% of these are vying for your attention. Some, like General Electric, attract hundreds of analysts. It’s hard to know anything about GE that other people don’t know. But among smaller companies, information is scarcer – buried in SEC filings, or locked up in the CFO’s mind, even in footnotes to annual reports. Reading about a company you never heard of might bring a diamond to light.
2. Look at the information everyone else ‘knows’ in a different way. Take IBM. Everyone knows it has a legacy business that is sliding; that it is in a turnaround; that the turnaround will take a long time; that it may not work. The market has been obsessed with these negatives. But also in the company’s reports are indications that its cloud computing business is growing fast. We’ve recently seen reports of the company’s efforts to gain contracts overseas with telecom companies; it may be just a matter of time before it is able to sign a major-ish contract with a US telco. Focusing on the positive, instead of the negative, might lead to a different conclusion about IBM’s stock.
3. Behave differently, related to #2 above. A great example of behaving differently was buying corporate bonds in 2008 and 2009 instead of selling them. Back then, Nordstrom’s bonds yielded close to 11%. IBM bonds were near double digits. The carnage was spectacular. Everyone and his brother was selling. Behaving differently – buying instead of selling – made a lot of money. In nearly every market, there is an opportunity to behave differently. Right now, energy stocks present that opportunity.

The last several months have showcased why many investors fail. In a nutshell, they behave badly. It is hard enough to save – which requires sacrifice; to make discernments about investable assets – which requires education; and to harvest results – which requires patience. Failures in these basics are vastly common. But even those who master these at least in part are capable of proverbially shooting their portfolio in the foot. Here are some examples, all of which have been on display recently:

• Buying into what’s doing well without conducting a rational analysis. There is a reason Amazon, Netflix, Twitter, Go Pro, FitBit, and so forth shot up to the stratosphere. It was investors buying their stocks. But none of these companies sells at anything even remotely resembling a decent value.
• Selling what’s doing poorly without conducting a rational analysis. While the earnings-lite group above was surging, tiny declines in earnings at spectacular companies trading at low valuations caused these stocks to crater further. But in the context of a multi year holding period, earnings misses of pennies, or even a dollar, are irrelevant, especially if they are caused by currency changes.
• Indexing. The index strategy is a triumph of thoughtlessness, and perhaps laziness as well. Hundreds of funds and managers have beat common index benchmarks over time. Finding them is not hard – Morningstar is available to anyone with a computer or a library card. The myth that active managers cannot outperform benchmarks is just that – a myth. On the other hand, we don’t mind if investors prefer to run their money via a computer, because it does create opportunities for thoughtful people.
• Picking on one or two holdings that happen to be at losses, when the balance of the portfolio is doing well. It’s great to optimize holdings; we spend a fair amount of time considering whether what we own could be improved by a swap to a new holding. But just because a stock has moved down since purchase doesn’t mean it’s a crappy company and should automatically be sold. It may only mean you bought it wrong. Don’t hold your buying decision against the stock; what matters is what it will do from now on, not what happened in the past.
• Timing the markets. It cannot be done. If you ‘win’ because you sell in time to avoid a crash, you will not get back into the market in time to reap the benefits of the recovery, which happens very quickly after bear markets.

There are other examples of bad behavior of course, but this roundup represents the most egregious examples we’ve seen lately.