Herd mentality is one of the strongest and most powerful human instincts. Humans take great comfort from walking the same path as others have walked before them, and nowhere is this more evident than in the field of investments. Most investors are simply incapable of disregarding the consensus when making investment decisions, if for no other reason than because ‘being out there on your own’ is associated with considerable career risk.
The 2002-03 season in the English Premier League, which ended with Sir Alex Ferguson winning a seventh Premier League title, developed into a hectic battle between Manchester United and Arsenal. At the height of the race for the title, with only a few weeks left of the season, Sir Alex uttered the now famous words: “It’s getting tickly now – squeaky bum time, I call it.”
Squeaky bum time describes very well my emotional state at the moment. Equity markets continue to set new highs, seemingly prepared to disregard economic fundamentals. I have never felt entirely comfortable when I struggle to rationalise investor behaviour and I am not alone. All over the world market pundits are busy declaring this rally the latest in a long string of market bubbles which have been doing the rounds over the past few years.
In his masterpiece The General Theory of Employment, Interest and Money John Maynard Keynes referred to what he called the ‘euthanasia of the rentier’. Keynes argued that interest rates should be lowered to the point where it secures full employment (through an increase in investments). At the same time he recognised that such a policy would probably destroy the livelihoods of those who lived off their investment income, hence the expression. Published in 1936, little did he know that his book referred to the implications of a policy which, three quarters of a century later, would be on everybody’s lips. Welcome to QE.
Demographics captivate me. There are around 7.1 billion of us occupying planet earth today, going to 10 billion by 2050. I often think about how good old mother earth will cope with the additional 3 billion people we are projected to produce between now and 2050. More people translate into increased pressure on already scarce resources, but that is only part of the story and a story well covered by now.
From an investment point of view, it is more interesting that over 150 million people from around the world join the middle classes each year. The Brookings Institution reckons that about 2 billion people can be classified as middle class today. By 2030, Asia alone will be the home of 3 billion middle class people, and the global middle classes will be approaching 5 billion, 90% of whom will come from countries we today consider EM economies. In other words, less than 20 years from now, Asia will have 10 times more middle class citizens than North America and 5 times more than Europe.
Whilst many chose to spend August on the beach, a full-blown crisis developed across emerging markets, and the BRICS in particular. The ‘B’ got into trouble with its currency under severe pressure. So did the ‘I’ and the ‘S’, whilst the ‘R’ and the ‘C’ both experienced loads of bad news on the economic front. Not exactly what you have come to expect from the BRICS.
All over the world we are confronted with political leaders who seem to care more about their own longevity than anything else.
A simple yet powerful example: Even at the best of times politicians like to run fiscal deficits as spending buys votes – Gordon Brown being the best example of fiscal irresponsibility that I can think of; however, it doesn’t stop there. Knowing very well that voters prefer transfer payments over more productive spending such as infrastructure investments, political leaders of all colours willingly deliver, even if it is plain wrong. Prostitution knows no boundaries.
Fear impacts our behavioural patterns, whether consciously or subconsciously. If someone threatens us with a knife, the instinctive reaction will be to take flight. If the stock market falls 20% in a single day, we will tend to react in very much the same way, even if the threat is not physical. Fear, like greed, makes people, and that would include investors, behave irrationally.
You may argue that physical threats cannot be compared to financial threats and, in some respects, they cannot, but research into the human brain suggests that it is the same part of the brain that kicks into action in both instances.
I often find myself caught between what is appropriate for the short-term vis-à-vis the long-term. Should I allow myself to become captivated by the long-term challenges that we are facing or should I do what the majority of investors seem perfectly happy to do – ignore the long term and focus on the present? Moral deliberations, career risk considerations, greed – you name it – all seem to be factors.
On 5 March 2013 the Dow Jones Industrial Average set a new all-time high, surpassing the previous high of 14,165.50, established back in October 2007. Only the stock market doesn’t seem to recognise that the world is a very different place today when compared to 5 ½ years ago. Many investors talk the bearish talk, yet they walk the bullish walk. This apparent inconsistency is a function of the widespread belief that central bank policy, whether emanating from Tokyo, Frankfurt, London or Washington, provides an effective volatility hedge, allowing investors to ignore the underlying economic and financial problems that continue to simmer.
The seemingly never-ending debate on passive vs. active investment management is beginning to annoy me. The discussion is one-dimensional and, at times, completely derailed. I shall be the first to admit that the long-only industry has not covered itself in glory in recent years. Nor has large parts of the alternative investment management industry for that matter. It is nevertheless the wrong discussion to have. Much more about this later, but let’s begin elsewhere.
I wrote a letter back in October of last year called When Career Risk Reigns (see here). More recently Jeremy Grantham of GMO published a letter called Investing in a Low-Growth World. The two letters address the same painful subject – how do investors get the most out of a low return environment and what returns can they realistically expect?
When I re-read my own letter from last October a couple of weeks ago after having read Jeremy’s take on the subject, I felt as if there were still some important aspects left untouched. I will deal with at least some of those issues in this month’s letter.