Reality bites: The cascading effects of misguided fiscal policy.

The economic cycle, in simple terms, is the process of moving from an excess of consumer and investment spending to stability, and then to deficit. New spending then begins the next virtous cycle. If income is pressured, so is spending. Lower interest rates and lower taxes will drive the recovery.

Ecinya 23/2/2001

TODAY’S FRONT PAGES………

are telling us that the Federal Government is about to ditch the promise of a budget surplus. The budget surplus was always a figment of the imagination of an inept Treasurer who in previous budget reportings was able to ‘cook the books’ by bringing forward income or deferring expenditure, or accruing income for the next rainy day and charging current expenditures to a prior period. That game is over with recession in Europe and the possibility of recession in America and a major slow-down in Australia in the September quarter which will likely flow into the fourth quarter.

‘Cooking the books’ functions best in the broader context of fabricating the economics. This was almost certainly a bit easier when Ken Henry was Treasury Secretary, but may have now become more difficult under Treasury Secretary Parkinson. The fiscal promise of the mining tax has faded, the costs of refugee policy have accelerated, health and education revolutions and climate change ‘initiatives’ have been expensive and counter-productive.

Also as companies move their operations offshore to escape the harsh business climate that Australia has become, so do they move their tax base, and do not have to suffer the delays that come from visitational over-kill from Occupational Health and Safety bureaucrats and doyens of the environmental world.

And the consumer who has watched his superannuation diminish, interest rates and electricity prices rise and his income stagnate and his job prospects and/or job security reduce has suffered a loss of confidence leading to him repaying debt and also paying lower levels of taxation.

Mr Swan has always told us that he ‘has the balance right’ because people on both sides of the economic debate were disagreeing with him.

Where did it all go so wrong? Ecinya covered this in a number of past Insight articles, but two will suffice to tell the story –

The real GFC – Government Facilitated Chaos

 

A reflection: Australia and the global financial crisis

 

FISCAL AND MONETARY POLICY

Sound monetary policy cannot function at optimum levels without there being in place sound fiscal policy. Fiscal policy and monetary policy are natural dance partners and the systemic and structural failings that are evident in Europe, the Middle East and America have been hidden under the blanket of reckless central banking, softened by the euphemisms ‘money printing’ and ‘quantitative easing’. The ‘fiscal cliff’ in a fiat money world is probably the latest hoax to obfuscate and mitigate responsibility for poor political policy and fiscal vandalism.

At home our Treasurer and last two Prime Ministers Messrs Rudd and Gillard have squandered the Howard-Costello-Hawke-Keating-Walsh legacy and exposed us to the Asian consolidation or slow-down, depending on your definitional perspective. Macro fiscal policy settings have dented, and in some cases, decimated consumer and business confidence.

It is likely that quantitative easing will, with the benefit of self-serving hindsight, come to be regarded as having solved some or all of the problems. The reality though is that one silver bullet does not create a recovery. It will really be a combination of factors that herald the end of one cycle and the beginning of another. One of Ecinya’s confidants (Dog) is already of the opinion that QE3 has some traction. In our view the main reason that problems are solved is because the personnel who gave rise to the problems in the first place have left the dance floor (George W. Bush, Alan Greenspan, Tony Blair, Gordon Brown, Strauss-Kahn, various Greeks with unpronounceable names and forgettable Italians such as Berlusconi etc.).

Ecinya is ever hopeful that their replacements are in possession of the velvet gloves and the iron fists which will save the world from its currently perceived and allegedly complex dilemmas, which are generally referred to as ‘crises’ so that an elected official can pretend to be solving the riddle.

If you then add in the occasional war such as Iraq, Afghanistan, Syria and Israel and Palestine and the resultant refugee problems, you can then understand how misallocation of scarce resources can lead to various calamities. Then just for a dose of spice add in the odd weather problem such as Hurricane Sandy. Before you know it fiscal policy suddenly adds up to a mountain of debt and current account and domestic deficits stretching well into the future.

AND just as you were getting comfortable will all of that the big question of ageing and demographics comes into focus.

BUT IT WILL ALL WORK OUT IN THE END

Cycles come and go. Within the cycles there are waves. The world is in fundamenatlly good shape and better times lay ahead. Getting the timing right is always THE CHALLENGE.

 

Kevin Armstrong: Investors must know what they are paying for and why one should be cautious!

Introduction

Over the last month there has obviously been a lot of news, particularly in the US around the election and its result and the focus on the fiscal cliff negotiations that have followed. However, from an investor’s standpoint very little has changed. In equity markets most were weaker in the early stages of November and recovered much or all that had been lost in the second half of the month, government bonds behaved similarly, only in reverse, as did the US dollar, and gold is still at the same price as it was at the end of October. With so little change in prices it is not surprising, but more than a little disconcerting, to see that the volatility index, the VIX, has quietly slipped down to a level of around 15. Throughout the secular bear market, which began in 2000, this measure has rarely been lower and all the subsequent increases in the VIX that have followed on from such low readings have been associated with equity market declines. Now is not the time for complacency and I continue to believe that a focus upon capital preservation, rather than chasing yield or return, will be the most prudent and rewarding course for investors to follow over the next six to twelve months.

Despite many markets having marked time over the last month and no changes having been made in my outlook for markets there are still a number of issues worthy of discussion. In this month’s Strategy Thoughts I explore the importance of investors knowing what they are paying for when it comes to portfolio construction and asset allocation through a concept known as ‘active share’. This was not a term I was familiar with until the middle of November but it highlights a shortcoming of the investment industry that I have long been aware of and have discussed many times in the past. That is  the tendency for fund managers and asset allocators to seek the comfort of the herd. This is ok during a secular bull market when a rising tide is lifting all the boats, but that is also the time when individual investors need less ‘professional’ (in that they are being paid for it) help. Through secular bear markets something quite different is required. I have also included some comments from John Hussman on why one should be cautious. His analysis of the current secular bear market and what returns can be expected will not sit comfortably with much of the asset management industry, but comfort and success rarely travel together for long in the investment business.

Finally I revisit the market performance of the largest company in the world, its recent ‘bear market’ and subsequent rally, and it’s so called ‘race to $1,000’ with a couple of other technology high flyers, and I have some follow up comments on oil and what it may be saying about where other markets may go.

‘Active Share’, know what you are paying for

The 19th November issue of Barron’s contained an article that I thought fascinating, and it highlighted a problem in the investment industry that is close to my heart. The problem relates to the desire on the part of fund managers to only do what they think will be a little better than everyone else, not what they actually believe is right. I highlighted this problem almost one year ago in a Thoughts and Observations piece titled ‘Accuracy is not enough! Anticipating surprises would be!’ In that article I noted that Ben Graham, Warren Buffett’s teacher, grew increasingly concerned about the investment industry’s ‘obsession’ with ‘relative performance’ rather than a longer term satisfactory return. At a conference, after hearing a fund manager state that “if the market collapses and my funds collapse less that’s ok with me. I’ve done my job.” Graham responded:

“I was shocked by what I heard at this meeting. I could not comprehend how the management of money by institutions had degenerated from the standpoint of sound investment to this rat race of trying to get the highest possible return in the shortest period of time. Those mengave me the impression of being prisoners to their operations rather than controlling them.”

I then went on to comment:

Investors who are obsessed with relative performance naturally succumb to herding, they don’t want to be too different from the rest, unfortunately the result will generally be disappointing. Perhaps institutional fund managers don’t feel that disappointment if their tracking errors are low, but the disappointment will be felt by their underlying investors.

Investment success comes from continually questioning what seems comfortable and appreciating that it is everyone involved in a market that makes a market, and that it is their collected expectations that are efficiently and perfectly reflected in that market at any moment. But the expected doesn’t drive markets, it is surprises that do that.

 The Barron’s article highlighted that not only is this tendency on the part of fund managers still present, it is actually growing. The journalist, Beverly Goodman, had moderated a panel at a conference where professor of finance at Notre Dame, Martijn Cremers, spoke. Cremers had originally conducted research into ‘active share’ a decade earlier while at Yale but had recently updated his research. Goodman outlined just what ‘active share’ was:

Active share is a measure of the portion of a mutual fund’s holdings that differs from its benchmark index. In other words, it’s a measure of how actively managed your actively managed fund is. Stated as a percentage of the fund’s holdings, it takes into account both security selection and any overweighting or underweighting of the stocks in a fund versus the index. "One of the most important considerations when buying an actively managed fund is that you expect the fund to be substantially different from the index," Cremers says. "Active share tells you what percentage of the portfolio is different."

Professor Cremers defines any fund manager who has an active share of 60% or less as ‘closet indexers’. For a fund to truly be considered active it should have an active share measure of at least 80%. What I found most intriguing, and to a certain extent worrying, in the article was that fund managers have been becoming more and more closet indexers. In 1980 half of all US large-cap mutual funds had an active share of 80% or more, by 2010 that number was down to just 25% of assets being truly actively run. A similar, albeit less severe, trend to closet indexing has been seen in the small-cap world as well. This trend may be understandable even if it is not necessarily healthy for investors. As Cremers put it:

"As a manager, you want to avoid being in the bottom 20% or 40%. The safest way to do that, especially when you’re evaluated over shorter time periods, is to hug the index."

One problem is that as a result many investors are paying active fees for something that is not truly active. If all one wants is the index then there are now a myriad of very cheap options, as Vanguard founder Jack Bogle frequently points out. An investor should not be paying an ‘active’ fee for what is essentially a passive approach. The second problem is that research shows that those funds that are truly active, i.e. with an active share in excess of 80%, tend to outperform their benchmarks by one to two percent a year.

Obviously this does not simply mean that any fund that is markedly different from its benchmark is going to outperform, but the only way one can achieve outperformance is by being different, and also skilful. It also means that investors should worry less about short term swings in markets and performance and focus more on what truly drives markets and returns over the longer term.

This approach to active share should also be applied to broader asset allocation decisions. The only way outperformance of a broad global benchmark, across asset classes, can be achieved is by being different. Naturally this will be uncomfortable much of the time, but an investor should not be paying active fees for a manager or adviser who opts to ‘hug’ the index in the pursuit of comfort. As the current secular bear market continues to unfold, and long term returns continue to disappoint, it is highly likely that ‘active share’ will become increasingly examined and discussed. In an environment of low returns active fees for comfort seeking passive management will not prove sustainable.

Why be cautious?

John Hussman of The Hussman Funds writes an excellent weekly market commentary. His publication of the 26th November, Overlooking Overvaluation, is well worth reading:

http://www.hussmanfunds.com/wmc/wmc121126.htm

His observations always tend to be longer term in nature than those of typical fund managers and in this publication he highlights just how far the US equity market is from being attractive over the long term, or put another way, just how far the US equity market is from being in the early stages of a secular bull market. I have pulled out a few of his thoughts on the US market;

·        Presently, on the basis of smooth fundamentals such as revenues, book values, dividends and cyclically-adjusted earnings, the S&P 500 is somewhere between 40-70% above pre-bubble valuation norms, depending on the measure. That’s about the same point they reached at the beginning of the 1965-1982 secular bear period, as well as the 1987 peak.

·         If presently rich valuations were to retreat again to undervalued levels that have accompanied the start of secular bull markets (see 1982 for example), stocks would produce yet another extended period of dismal returns. 

·        At present, the return of the S&P 500 over the past decade – though below average – has actually overshot what would have been expected in 2002. This reflects the fact that valuations today are still well above their norms. Unless we assume that valuations will remain rich forever, this doesn’t portend well for returns going forward.

·        A fairly run-of-the-mill normalization of valuations in the course of the present market cycle would imply bear market losses of about one-third of the market’s value, without even establishing significant undervaluation.

·        Still, it’s worth a moment’s consideration that “secular” lows (which we typically observe every 30-35 years, most recently in 1982, and that serve as launching pads for long-term market advances) have usually been associated with declines in normalized price-fundamental ratios to about half of their historical norms. Such an event even 15 years from today would be associated with an estimated annual total return of just 2.7% for the S&P 500 between now and then. Such an event a decade from now would be associated with a negative expected total return for the S&P 500 in the interim. And while it’s not our expectation, such an event in the present market cycle would make “S&P 500” not just an index, but a price target.

The secular bear market still has a long way to run either in terms of price decline, time, or more likely a combination of both.

From a shorter term perspective his conclusion is unequivocal;

“Stocks are overvalued, and market conditions have moved in a two-step sequence from overvalued, overbought, overbullish, rising yield conditions (and an army of other hostile indicator syndromes) to a breakdown in market internals and trend-following measures. Once in place, that sequence has generally produced very negative outcomes, on average. In that context, even impressive surges in advances versus declines (as we saw last week) have not mitigated those outcomes, on average, unless they occur after stocks have declined precipitously from their highs. Our estimates of prospective stock market return/risk, on a blended horizon from 2-weeks to 18-months, remains among the most negative that we’ve observed in a century of market data. (Emphasis added).

Whether the next cyclical decline brings about valuations that could also mark the end of the secular bear market only time will tell. Either way, it currently seems prudent to be cautious about the outlook for the US market over both the cyclical and longer term secular time frame.

Why Secular moves occur?

Secular, very long term, moves in markets tend to last decades, as Hussman points out, and they travel from one extreme of long term valuation to the opposite long term extreme. This raises the very sensible question; why? The answer does undoubtedly have something to do with the overall state of the economy and the world but the overriding feature is the tendency of human beings to forget the past and to extrapolate the present into the future, and we do this through both good times and bad. Eventually at the end of the move the memory of the past has so faded that ‘new era’ or ‘this time it is different’ attitudes emerge. ‘This time is different’ was the title of Carmen Reinhart and Ken Rogoff’s ground breaking book on eight centuries of financial folly published at the depths of the GFC. They were both interviewed recently and one of Reinhart’s answers touched on why secular moves occur:

“You go through history and, in good times, the tendency is to liberalize. Then a crisis happens, and you retrench. But the retrenchment lasts only as long as your memory does, and memory is not that great. Not the memory of the policy makers and not the memory of the markets. So as you start putting time in between where you are now and your last crisis, complacency sets in, and you begin to be more cavalier about what your indicators or warning signals are showing. That’s the essence of the this-time-is-different syndrome. The debt ratios are X, but we really don’t have to worry about that; the price-earnings ratios are Y, but that’s not a concern.

And so, given that this is so grounded in human nature, I’m extremely skeptical that we will overcome financial crises in any definitive way. We may have longer stretches [without a major crisis], as we did after World War II during the era of financial repression, which grew out of the crisis of the early 1930s. Back then, you had a lot more regulation and clamps on risk-taking, both domestically and cross-border. But then we outgrew it. It was passé. Who needed Glass-Steagall?”

Markets are undoubtedly ‘grounded in human nature’. No matter how hard ‘they’, whoever they may be, try, markets are certain to continue to exhibit the same booms and busts. The important issue for an investor is to recognise this and to incorporate a secular perspective into asset allocation and investment decisions. The way one invests during a secular bull market has to be different to the approach during a secular bear market. This can easily be seen over the last dozen years, compared to the preceding dozen years.

Since 2000 the cyclical moves have dominated while the major markets of the world have largely marked time or declined. This was quite different from the late eighties through to 2000. Over that period cyclical selloffs, even those associated with the 1987 crash and the Gulf War could largely be ignored as eventually the longer term secular trend swamped those falls.

Buy Asia Now?

Jeremy Beckwith, formerly CIO with Kleinwort Benson and now CIO with online fund manager Nutmeg, writes regular blogs on investing and economics. Last week he wrote the following:

Buy Asia, 21 November 2012 

It has been well understood for some years now that the driving force of global growth over the next decade is most likely to be the rise of the middle class consumer in the larger emerging economies, mostly in Asia.  This argues for heavy exposure, on a long term or secular view, to Asian stock markets and those Western companies that are successful in selling to the Asian consumer.

This secular view does however, from time to time, encompass cyclical periods of weakness, and the Asian stock markets have endured such a period over the last year and a half.  Current price levels in Asia provide an excellent opportunity for investors to buy into the key secular trend at a cyclically opportune moment.

And across LinkedIn Jeremy sent the following:

‘Both the secular trend and the cyclical indicators say very loudly to BUY ASIA’

It is refreshing to see other commentators taking both a secular and cyclical view. However, whilst from a secular standpoint I do tend to share Jeremy’s view, cyclically I am not so sure. I have long maintained that many Asian markets saw their secular bear markets end in the early 2000’s when valuations were historically low. A new secular bull market is therefore at hand; my concern is that in many of those markets cyclical declines, even within a secular bull market, can be enormous. As an example the Korean KOSPI ended a secular bear market in early 2003 at a level of 512, the same level it had first achieved almost sixteen years earlier. From that low point it began a new secular bull market and the first cyclical rise saw it quadruple to its peak in October 2007. From there it’s cyclical decline, despite the secular bull market remaining intact, wiped 57% off the market’s value.

Apple Crash and the race to $1,000

I first discussed Apple and the amazing expectations that it was by then attracting, in the April 2012 edition of Strategy Thoughts.

I touched on the subject again the following month and concluded that discussion with:

Clearly there is some scepticism about the wisdom of this move on Piecyk’s part, again this further illustrates the near universal conviction that Apple can only go ever higher and therein lies the risk.

Apple, Priceline and Google race to hit $1,000-a-share mark, USA TODAY, 4 April 2012

The headline above captured the mood surrounding Apple in particular, and two other stocks whose prices had been rising earlier this year. Apparently the race was on to become a $1,000 stock. At the time Apple and Google were both in the low $600’s and Priceline was just below $750. Priceline had very nearly done it before, the online travel company soon after its initial public offering in early 1999, close to the crescendo of the tech boom, hit $990 a share. But then after the bust the shares fell to below $8 a share in late 2000. Priceline’s most recent assault on $1,000 began in late 2008, during the depths of the GFC with the stock trading in the forties. From there it moved up to its peak just below $800 almost exactly coincident with the rash of forecasts of $1,000. At its recent low the stock, rather than sprinting the last $200 to the apparently inevitable millennial mark, had fallen more than $200. Google’s run up too can be dated back to late 2008, but its price has only tripled over the intervening few years to its peak, a little later than Priceline’s, in the first week of October. Since then its price fell $120 to below $650 at its mid November low.

Apple’s run up and reversal has probably been the most widely followed, understandably given it is the largest company in the world. Its latest bull market can be dated back to very early 2009 when its price was briefly below $80 and from there it began its meteoric, and now widely publicised, rise to its recent peak in mid September at $705. Like Google, a little after Priceline’s peak and the media frenzy over the prospect of a $1,000 price tag. Apple’s reversal has been more severe than Google’s and steeper than Priceline’s as over just nine weeks it lost 28% of its value, or two hundred dollars a share, down to its mid November low.

Throughout the decline that Apple suffered in October the media was filled with upbeat interpretations of the decline in Apple’s share price with the following Seeking Alpha headline and comment capturing the popular mood:

Apple Below $600: Trick Or Treat?

The article appeared on the website on the 1st November by which time the stock had fallen to just below $600 from just above $700 in less than six weeks. There was no sense of alarm in the article, it merely stressed the positive qualities of the company and comforted investors with the seemingly comforting observation:

 “Even good stocks experience healthy corrections from time-to-time.”

Over the years I have frequently warned readers of the danger of those two words (‘Healthy’ and ‘Correction’) when they are strung together to soften the damage that has always already been done. There really is no such thing as a healthy correction; it is an oxymoron when it comes to investing. No one is genuinely pleased to have suffered a loss of even ten percent, let alone twenty, or the twenty eight that the Apple decline turned in to. True buying opportunities, after sell-offs in the early stages of long and rewarding bull markets, are never seen as ‘healthy corrections’, rather they are always seen by the majority as the resumption of the miserable bear market that had in fact already ended. In the very early stages of any bull market the majority will always be looking for reasons to sell, not to buy, similarly in the final stages of a bull market the majority will always be looking for rationalisations as to why the longer term uptrend must still be intact. That is when the ‘healthy correction’ always gets trotted out. This is not to say that every time the term is used that the bull market is over, but it does indicate that it is ageing, and the early stages of all declines, that ultimately become devastating bear markets, are always hopefully seen as ‘healthy corrections’ by the majority.

A sign that at least some respite in the Apple bear market could be expected was given in mid November. An amazing reversal in investor attitudes was highlighted by the following headline on CNBC’s website; it appeared on 15th November:

Apple Stock Hit by Panic Selling: ‘Someone Yelled Fire’

Chart forApple Inc. (AAPL)

The article began with the highly charged and highly emotive comment:

“Forget the “fiscal cliff” the real panic on Wall Street is over Apple’s stock”.

Ironically the giving up on the ‘healthy correction’ line in favour of the more emotive ‘Panic’ and ‘Fire’ came the day before Apple’s share price began its best recovery since the stock peaked two and a half months ago. That recovery may now be rolling over.

It may be the case that the recovery of the last couple of weeks is nothing more than what could be called a ‘healthy correction’ to the bear market, or a ‘bear market rally’, but don’t expect to see that type of commentary on mainstream media until the bear market in Apple, and probably the broader market as well, is much more established and widely accepted. At such a time any bounce like that seen in Apple will be dismissed as nothing more than a ‘dead cat bounce’ or a ‘suckers rally’. This is the attitudinal backdrop found at the beginning of long term bull markets just as the healthy correction belief abounds at and through bull market peaks.

Oil and the market, a follow up

Chart foriPath S&P GSCI Crude Oil TR Index ETN (OIL)

Two months ago, in the October edition of Strategy Thoughts, I included the chart above as a means of illustrating how, over the last few years, a decline in the price of oil, rather than being good for the stock market, has heralded a decline.

I concluded that discussion with the following comment:

More recently, and in another indication of the ‘breadth’ of the overall global rally deteriorating, oilsuffered another setback falling, so far, 15% to its recent low. Whether this is the beginning of anothersignificant plunge for oil only time will tell but again it is interesting that US equity markets are grimlyhanging on at the same levels they held when oil began its latest fall.

 

Chart foriPath S&P GSCI Crude Oil TR Index ETN (OIL)

Since then, as the second chart above illustrates, the oil price decline has become more severe and now the market has joined in. When oil made its peak prior to the recent decline the Dow stood at 13,653 and it was still very close to that level when the October Strategy Thoughts was written and remained there for another couple of weeks. Since then the Dow fell a little over 9%, or more than 1,000 points to its mid month low. This should be a cause of some concern for all those who are hoping that somehow this time around lower oil prices will be a good thing for the market. As noted last month the deflationary forces continue to grow and it seems that the equity market is now picking up on that trend as well.

What about the inevitability of ever higher prices? (Or forecasts built on so called economic fundamentals?)

As the peak in oil prices was approaching last year the media was obsessed with the idea that they could only go one way – up!

The new geopolitics of oil, Financial Times, 6 April 2011

‘A new dynamic has emerged in oil markets that is likely to push prices on to a higher path in the years ahead than almost anyone had forecast a year ago. It relates to the now unfolding critical dimensions of what can be called the “new geopolitics” of oil.’

We now know of course that despite the fears being a wonderful extrapolation, they were unfulfilled. At the next, slightly lower peak in March of this year, a similar fear was present:

Oil prices: 10 reasons to be fearful, The Guardian 2 March 2012

The article began:

‘Oil prices have surged by more than 12% since the start of the year to hit $125 a barrel and some analysts see them pushing even higher to $150.’

Again, we now know that this is not quite what happened.

At least the International Energy Agency has recognised the difficulty in forecasting oil prices:

Long-Term Oil-Price Forecasting Is Highly Uncertain, IEA Says, Bloomberg, 12 September 2012

Forecasting oil prices beyond a year is “highly uncertain” because of the need for more transparent data from suppliers and consumers, according to the international Energy Agency. “Forecasts based on futures prices, surveys of analyst forecasts, forecasts based on a variety of simple time series regressions and other common forecasting techniques are generally inferior to the random-walk forecast, which implies that the best forecast of crude oil spot prices is simply the current price of oil,” the Paris-based IEA said today in its monthly Oil Market Report.

Unfortunately they may be being a little optimistic in implying that they can predict even one year ahead. History has repeatedly shown that despite some analysts knowing that they don’t know, they cannot resist extrapolating recent trends, and the longer the trend has lasted the greater the confidence in the extrapolation, and this is not only true in commodity markets. In oil the same behaviour has been seen at troughs, only then the extrapolation is usually for things to fall even more;

Undoubtedly there will be much learned discussion regarding supply and demand of all sorts of commodities, all with solid so called ‘economic fundamentals’ to back it up. Most of the time these forecasts will do no better, as the IEA pointed out, than random walk forecasts, but at extremes they are likely to be dead wrong.

Gold

Richard Russell, the octogenarian writer of the Dow Theory Letter has been, quite correctly, a bull on gold for much of the current bull market. He remains a long term bull largely due to his total fear of the Federal Reserve and their printing presses, however, even he noted recently that there may be a few too many Johnny come lately bulls:

“Over the last month there was too much eager talk about gold and silver. I was receiving a bullish mailer every day telling me about the fortune I could make by buying this or that "little-known" gold stock. So far, I’ve passed on all these fortune-making opportunities. Where were these guys ten years ago when they were giving away top-quality gold stocks? Investing is a strange business. They’re scared to death at the bottom and hot as a branding iron at the top.”

His description of ‘scared to death at the bottom’ and ‘hot as a branding iron at the top’ are neat descriptions of secular troughs and secular peaks. I would also note that I was intrigued to read this weekend in Barron’s that the correlation between gold and inflation over the last quarter of a century has been a staggeringly low 1%. This should provide very little comfort indeed to those Johnny come latelys stocking up on gold now on fear of inflation in the future. I remain very sceptical of the enormous gains that so many are now forecasting for gold. As Russell asked, ‘where were they ten years ago?’.

Conclusion

The last month has delivered nothing in the form of market action to cause me to change my very cautious outlook on the world. As I said in the introduction now is not the time to be chasing yield or return. What we have seen over the last month are numerous examples of the kind of market action and response that confirms to me that markets continue to be a wonderful barometer of aggregate social mood. It may make investors more comfortable to believe that somehow economics is going to tell them where markets will go but, unfortunately, that comfort comes from our deep seated desire to herd, and herding is a particularly unrewarding behaviour during secular bear markets.

The current secular bear market continues to unfold in many of the developed markets of the world and likely still has further to run in terms of both price and time. It is therefore not too late for investors to measure what they are getting from investment providers and to understand what they are paying for. ‘Active Share’ will likely become a more important consideration for investors as the secular bear market continues and returns in general remain low.

In closing I would like to wish all readers of Strategy Thoughts a happy and rewarding holiday period and would encourage them to visit www.bbbb.co.nz. This is my website that is now up and running. My book, Bulls, Birdies, Bogeys and Bears, is prominently featured on the site and readers can sign up to receive Strategy Thoughts at the site and also read archived editions. Naturally feedback would be most welcome.

This will be the last edition that I will be emailing out directly so please sign up on my website and let any of your friends, clients or colleagues know that this is available.

Afterthought

Several years ago I recommended a book by Frank Partnoy: ‘The Match King: Ivar Kreuger, The Financial Genius Behind a Century of Wall Street Scandals’. It was published in 2010 and beautifully illustrated that whilst Bernie Madoff may have been a bigger fraudster than any of his predecessors he hadn’t done anything new. I have just finished reading Partnoy’s latest book: ‘Wait, The Useful Art of Procrastination’. It sheds some fascinating insights on everything from high speed trading to the invention of the Post-It note and towards the end he introduces the reader to ‘The Einstellung Effect’. In German the word Einstellung means attitude and the term Einstellung Effect refers to our tendency to get stuck in our ways ‘to act or think in the same manner we have always acted or thought, even when we are presented with alternatives that are obviously better.’ He points out that the best innovators do not develop such an attitude.

This is just as true for investors because as human beings we like to seek comfort, we herd. One of the ways Partnoy suggests of avoiding the Einstellung Effect is to avoid known, comfortable situations, or at least to be aware of their potential drawbacks. We all need to break out of our comfort zones but this is so hard. Partnoy quotes Keynes on this subject: ‘The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been,…. into every corner of our minds.’

The Einstellung Effect is undoubtedly powerful but just as all great innovators avoid it so too do successful investors.

One pleasing finding of the book is that, as the title implies, some procrastination can in fact be quite useful.

Kevin Armstrong

4th December  2012

Disclaimer

The information presented in Kevin Armstrong’s Strategy Thoughts is provided for informational purposes only and is not to be considered as an offer or a solicitation to buy or sell particular securities. Information should not be interpreted as investment or personal investment advice or as an endorsement of individual securities. Always consult a financial adviser before making any investment decisions. The research herein does not have regard to specific investment objectives, financial situation and the particular needs of any specific individual who may read Kevin Armstrong’s Strategy Thoughts. The information is believed to be-but not guaranteed-to be accurate. Past performance is never a guarantee of future performance. Kevin Armstrong’s Strategy Thoughts nor its author accepts no responsibility for any losses or damages resulting from decisions made from or because of information within this publication. Investing and trading securities is always risky so you should do your own research before buying or selling securities.