The Financial Seminary
Easter 2014 & The Resurrection of Greed?
My experience is that most Americans have little, if any, understanding of the connections between religion and investing. But before he died, legendary mutual fund manager Sir John Templeton toldForbes magazine, "Religious views are important to whatever anyone does--investing, writing articles, anything. It's the most important thing there is because you think most clearly when you're at peace with yourself and your Creator." The cover of that issue of Forbes depicted John with his other famous counsel that the key to successful investing in any asset--stocks, bonds, real estate or private business--is to courageously buy when others are fearfully selling and to prudently sell when others are greedily buying. For two decades, I've worked to help people better understand that crucial element of John's thinking. I've had very little success. The recent financial media suggests one more attempt might prove enriching to those who might listen.
At root, as demonstrated by the biblical story of Noah, about which there's a new movie, faith is about the extraordinary ability of some to know what our Creator is up to in our world. That abiity is far beyond what our normal senses can tell us. Just as importantly, if not more so, as also demonstrated by Noah, true faith is about the courage to act unpon what that ability is telling us to do, even if others can't see or hear the wisdom of doing so. For example, John was famous for buying Japanese stocks just after World War Two as he believed better days lay ahead for that devastated nation of industrious people who had been misled into war. After the crash of the US stock market in 1987, John famously bought a lot of US stocks. That also took a lot of faith as the vast majority of people thought our economy and markets would never recover. As many worried about the federal debt during the early nineties, John famously predicted a soaring stock market for that decade. In short, John always had faith that our Creator, a term he used instead of "God" with the secular media to keep it from being edited out, was helping people to grow more prosperous on average. As Jesus said, the moral dimensions of reality have developed so that humanity "might have life and have it more abundantly." Economic historians indicate that increasingly prosperity has generally been the case over the centuries. So John thought there was usually a good place to invest if one was open-minded enough to look around for it, rather than being paralyzed by fear or greed.
But John was no Polly Anna either. When everyone thought in 1999 that Internet stocks could only go up, John correctly predicted most would go bankrupt and the Dow Jones would make nothing during the first decade of the new century. He was right about both. In 2006, John warned the leverage on Wall Street from its sub-prime mortgage activities would cause "financial chaos." He added that once that chaos subsided, we should buy stocks. Again, he was prophetic. I truly wish John was here to guide us today, not that most would listen. It seems clear that most investors have learned little, if anything, about fear and greed during recent decades.
A headline in the April 16th issue of The Wall Street Journal said, "Schwab Feasts as Investors Devour Stocks." The article said Schwab's profit rose 58% as "the discount broker rode a record wave of trading by customers. The results provided more evidence that individual investors are ramping up trading after mostly laying low in the wake of the financial crisis in 2008. The San Francisco-based company executed an average of more than 550,000 trades a day during the quarter, the highest volume in its history." A similar Journal headline of April 24th said, "Mom and Pop Step Up Their Trading." It detailed that other discount brokers were also seeing record trading. Of course, John and Warren Buffett's favorite stock market indicator--the total value of stocks as a percentage of GDP--was at 55% in 2009, a clear buy signal, but is at 117% today, which indicates the market is fully valued, or more, which has historically occurred when the ratio has hit 90%.
Yet none of this may indicate the end of the current bull market is at hand. Another market truism is "never fight the Fed" and the Federal Reserve is still providing easy money. While that could end in coming months, the Bank of Japan will create more money this year than the Fed did during QE and QEII combined. This is why Bain & Co has projected the amount of capital in the world's markets will increase from about $600 trillion recently to $900 trillion by the end of this decade. If history is any indicator, that could mean today's over-valued stocks will become very over-valued and another bubble like 1999. Yet it could be even more serious. The bubble of 1999 was almost entirely in technology stocks. Today, most sectors of the stock show signs of being over-valued. So at least the beginning of the end could be within sight...at least for those who have seen that history may not be a guarantee of future performance but is worth seriously considering anyway. As John also famously said, the four most costly words in the English language are "it's different this time."
The herd-like tendency of unsophisticated investors to buy when others are greedily buying and to sell when others are fearfully selling is why most grossly under-perform the market. An April 14thMarketWatch article from the Journal has just detailed that a new study by market research firm Dalbar found that over the past thirty years, the S&P 500 Index has returned 11.11% annually but investors have only earned 3.69% annually, a short-fall of 7.42%. The study also said that during the bull market of the past year, the S&P returned 32.41% while investors earned 25.54%, a short-fall of 6.87%. The report concluded, "After decades of analyzing investor behavior in good times and in bad times, and after enormous efforts by thousands of industry experts to educate millions of investors, imprudent actions continues to be widespread...Attempts to correct irrational investor behavior through education have proved to be futile. The belief that investors will make prudent decisions after education and disclosure has been totally discredited."
The article blamed the financial services industry and the financial media. But John knew it was about human nature. And the fact that do-it-yourself investors at discount brokers are jumping in after avoiding the market for years suggests the pervasive financial media is more likely responsible. Yes, that could be a self-serving observation by a financial advisor but John also thought the media was a primary distraction for investors and sought to ignore it. For example, the financial media has recently focused on high frequency traders. But what investors lose to them is a pittance compared to the cost of financial ignorance. For example, a recent survey cited by the Templeton funds showed sixty percent of investors still believe bond prices will actually rise if and when interest rates rise. That confusion could cost investors quite dearly if and when the Fed turns from friend to foe. And there's surely still someone at the Fed who remembers the old saying that it's the Fed's job to take away the punch bowl just as the party starts to rock.
It would also be nice if we could depend on professional fund managers to protect us from our very human tendencies to believe what others, such as the media, tell us to believe at the moment. But the April 22nd issue of the Journal said thateven comparitively sophisticated investors continue to move from mutual funds to hedge funds even though the average hedge fund manager made about 9% after fees during 2013. Even hedge funds focused on stocks returned 14% compared to the 32% return of the S&P 500. The article added that some stock-focused funds were down double digits during the first quarter as the managers had invested heavily in popular technology stocks, which suffered during the first quarter. Hedge funds also invested a record amount of money in European stocks during the first quarter, which we've recommended for over a year or more. The April 1st issue of the Journal noted their increased buying, combined with the lackluster performance of the US market, has now put European stocks ahead of domestic stocks over the past calendar year. All this is likely why Warren Buffett has bet that even the best hedge funds won't beat the S&P over time.
So what's all this mean for today? Well, many in the media now suggest investors should stop trying to time the market, as the media has encouraged them to do over the years, and simply invest in the S&P 500 and leave the money alone. But doing so now would mean you are doing what everyone else is now doing, precisely at the time we should be considering some profit-taking in US stocks. Of course, when people take profits in US stocks, the money does not disappear. It simply moves from one pocket to another. So there could be be more room for European stocks to advance. On average, since the Great Recession, US stocks have risen 30% more than European stocks. Few individual American investors have been interested in Europe due to media accounts of Greece and so on. But in reality, Greece has been the best-performing stock market in the world during the past year, which has rarely been reported. And while the European Central Bank has resisted the easy money policies of the US and Japan, it may yet be forced to join the US and Japan to prevent major imbalances. If the ECB does cave, European stocks could do quite well, which is what the hedge funds are obviously counting on.
But it may also be time to look at the developing markets of the world. They are Jeremy Grantham of GMO's favorite asset class for the next seven years. He expects US stocks and bonds to stagnate, actually producing negative real returns over that time. Since John died, I've relied heavily on Jeremy's views, with similar good experiences. Jeremy is another grumpy old man of Wall Street who has studied enough economic history and human nature to do his own thinking regardless of what Wall Street and the financial media say. When the market peaked in 2008, Jeremy said he'd buy when prices halved. Most laughed at him. But a year or so later, he bought stocks at half price when others were scrambling for T-bills. Will he prove prophetic again? I don't know. But I intend to keep the faith that served John so well for decades. For from the time people laughed at Noah, the time the Israelites at the base of Sinai created the golden bull despite the guidance of Moses, the time Jesus' contemporaries voted for the release of Barabbas, and the time Americans thought Y2K was a big deal, the crowd has tended to make very human and very costly mistakes. So here's hoping this season of resurrection reminds you of the upward sloping but still cyclical nature of economic reality.
The Financial Seminary