The Dismal Science
With the airwaves filled with economists calling for recession and inflation, we think it is important to remember the John Kenneth Galbraith quote, “the only function of economic forecasting is to make astrology look respectable”. Warren Buffett has another good quote about forecasts, “Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.” More important to us than catchy quotes is an article published by the CFA Institute Journal Review that found no significant evidence of positive correlation between stock markets and gross domestic product (GDP). Thus, we caution against equating stock market and economic performance as one and the same. Recessions are a natural occurrence, but economists call on timing, length, and depth of recessions have historically been less than helpful. JP Morgan’s Michael Cembalest noted in a recent study that history shows equity markets bottom well before the economy stops worsening. In other words, economists are backward looking when it comes to data while the stock market is more forward looking. More than likely, by the time the esteemed economists land their jets in some picturesque resort and sound the trumpets that we are in a recession, the market will be turning or on the way up.
Progressing away from the recessionary talk, we want to highlight the stock market. For perspective, the stock market falls on average 20% every three years[1]. However, that same stock market has annualized 7.5% from 2001 to 2020, 11.5% from 1950 to 2021, [2] and 10.49% from 1926 to 2022[3], to provide varying frames of reference. Unfortunately, many do not have the expectation the market may fall 20% on a regular basis. Therefore, they bounce in and out of the market hurting their returns based upon pearls of wisdom dropped from the same people who last year told you inflation was transitory and the subprime mortgage market was contained in 2008. As we have maintained for decades, we believe staying invested throughout the cycles of the market is vital if one wants to keep up with inflation levels not seen since 1981.
Indeed, the question falls back to, how does one stay invested when the market and economists assail one’s emotions? Here is where we reference our long-term plans and strategies. Tactically, we have kept fixed income duration low, used cash as an asset class, and added commodities to portfolios to help reduce interest rate and currency risk. In addition, we have emphasized low duration equities over long duration assets such as unprofitable growth stocks. Strategically, we have used managers, who over time, have shown the discipline and conviction to mitigate downside risk by holding cash/gold/and cheap equities when pockets of the market appear overvalued but who are also patient enough to put that same cash to work when the market falls to more attractive levels. This “investing in a bear market” is how one positions for profit in future years, as the saying goes, you just don’t realize it at the time. This patience and conviction is easier to fall back on when you have the long-term framework and strategy put together from years of financial planning.
Of course, one probably wonders, where do these opportunities reside? In a circular way, this points back to our flexible mandate managers who have put cash to work in sectors like financials that have stellar balance sheets but investors are punishing because they fear another 2008/09 market scenario. Or let’s say they are dipping into healthcare or biotech stocks where some companies are trading for less than the cash on their balance sheet. In addition, they could also drop down into an area of the market like small capitalization value stocks that are 20% below their 20-year average historical Price-to-Earnings ratio or small cap growth stocks that are 35% below their 20-year average historical valuation levels, as well. International stocks have underperformed domestic stocks for nearly 15 years now, so there are areas where managers could possibly make generational investments given the price level of those companies. The point is, there are opportunities when markets are volatile and we feel fortunate to have the flexibility to capitalize on these investments as they arise.
To that end, please keep in touch as we think our long-term strategy affords opportunity right now, but we know the financial media and economists have been painting a stormy picture that many can’t see through. Economists have a difficult job and it was not our goal to denigrate the dismal science (as Thomas Carlyle so named the field of economics years ago). It was our intention to highlight the difficulty in modeling a complex adaptive system like the economy and how the saying “All models are wrong, but some are useful” seems to apply. To quote Warren Buffett, “You cannot get rich with a weathervane.” To us, it’s more important to buy attractively valued assets with long-term growth potential that will allow us to endure whatever economic storms arise. Any other plan is akin to flying a plane into a storm cloud with no instrumentation or flight coordinates.
P.S.- On the subject of taking a trip with coordinates and instrumentation, our dear friend, Scott Mauldin is waking the Pacific Crest Trail. His trail journal is https://www.trailjournals.com/journal/25382. We highlight Scott’s journal for two reasons. One, because actively pursuing dreams and taking adventures is something we encourage. Two, because Scott quotes Emerson in his journal “Adopt the pace of nature: Her secret is patience.” Patience is vital to the art of investing and something we think should be highlighted. Stay patient, friends.
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If you buy and sell a security in a taxable account on or after the effective date, NFS will report cost basis for the sold security to you and the IRS on Form 1099-B. If you have a mix of covered and uncovered positions in the same security, NFS will report cost basis to you and the IRS for any covered position that is sold. NFS will apply the FIFO (First In, First Out) default method unless you inform us of a different method. Your cost basis method for all transactions must be final by settlement date. If you choose to change the default method, you can do so by notifying your Financial Consultant.
Use of Indexes
iThe investment return and style information and comparisons employ a variety of popular indices, and the index contents and strategies are the property of their respective companies (e.g., Dow Jones, Standard & Poor’s, Morningstar, Barclay Capital, Russell). Although the data is believed to be reliable, CFG makes no warranty with respect to the contents, accuracy, completeness, timeliness, suitability, or reliability of the information, which is represented here for informational use only and should not be considered investment advice or recommendation. None of the indices can be invested directly, and the return figures for these various securities indices are reported without management fees, trading costs, or other expenses subtracted from the returns, and are shown on a total return basis that assumes reinvestment of applicable capital gains and dividends. Components of indices may change over time. Small capitalization stocks are represented by the Russell 2000 Index. Mid Capitalization stocks are represented by the S&P Mid Cap 400 Index. Foreign stocks are represented by the MSCI EAFE Index and emerging markets are represented by the MSCI Emerging Markets Index.
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[1] Bartalos, Greg. “Chris Davis Picks Stocks, Praises Buffet, Rips Politicians”. From Barrons, June 14, 2022, https://www.barrons.com/advisor/articles/podcast-chris-davis-funds-stock-market-buffett-51655232756?mod=article_inline
[2] Source: JP Morgan Asset Management, Guide to the Markets—U.S., June 30, 2022
[3] Davis, G. Brian. “Historical Stock Market Return: Average S&P Returns Since 1926”. From SparkRental, March 29, 2022, https://sparkrental.com/historical-stock-market-return/
