Down is More

Investment Perspective – February 2019

“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business” 

Peter Flannery

As value investors, who prefer to invest in the business rather than play the stock market, we know that the intrinsic value of the business is entirely different and separate to the trading price. 

Although it is not easy when markets are generally happy and prices stretched, we continue to look for good businesses whose prices offer a reasonable buy-in point. 

The lower the price then, the better the buying. 

That is because the trading price and the underlying intrinsic value of the business are not one and the same. 

They are different and separate. 

The further down the price trades, the more we like it … down is more!

 COUPLE (A) AND COUPLE (2)

At WISEplanning, we offer a range of programmes and services to help Kiwis either get enough money to be truly financially independent (beyond the standard $700,000 in a Kiwisaver scheme, that most aspire to!) or to protect and grow the capital already accumulated. 

What we need to do to get money, is not exactly the same as what we need to do to manage the money we have already got. 

Anyway, a couple of years ago, we used Facebook to send our message out to the world and referred to Couple A, who are typical clients of WISEplanning and Couple 2, who in many respects outwardly looked the same as Couple A, but had a different approach to things.

Simply, Couple A are progressive, openminded, determined, work with a team of advisers and are reasonably likely to finish up in the top 5% of wealthy New Zealanders at some point in the future. 

Couple 2, on the other hand, whilst they are also business owners or professionals and live in the right part of town, drive nice cars, are educated etc, outwardly look like they are in a similar position to Couple A, except they are not. 

They like the idea of being progressive but they are not ones to always follow through, letting lifestyle choices get in the way of progress and take priority. 

They are educated, earning good incomes but are also able to rationalise anything to suit their viewpoint at the time (sometimes at the expense of real progress). 

On a good day, they get determined and focus on getting ahead.  However, when life does not quite go their way, they unfortunately lack the structure and determination to work things through for the greater good, long term.

Amusingly, one of my team members saw that I was referring to Couple A and Couple 2 and thought I had made a mistake.  So, she changed (from memory) Couple 2 to Couple B. 

The reason for demonstrating Couple A versus Couple 2 is because A is alpha and 2 is numeric.  In short, these are different languages.   Some understand the “language of money” or can learn it – others not so much.

COUPLE A AND COUPLE 2, AS INVESTORS

Because of the planning, the structures that have been implemented, the guidance and help they have received, along with their determination to succeed, Couple A generally have more money to invest than Couple 2.

Couple A seek out advice and follow it, raising questions along the way and tend to follow the advice as it is outlined. 

Couple 2 are more inclined to do it themselves, or if they seek advice, capitulate and blindly follow the adviser.   But, they can sometimes be quick to blame the adviser when markets oscillate because they do not understand what is going on. 

Couple A quickly catch onto the idea of price and value not being the same thing.  Couple 2 say they get it and certainly do, whilst prices rise but when prices decline, they seem to forget. 

Couple A like averaging down and are sometimes proactive, sending e-mails to my office, looking for ways to average down when markets decline.  Couple 2, on the other hand, tend to remain silent, which is because they either have not looked, are not aware or adopt an avoidance approach by getting busy with other things, so they do not have to look at the cash up value of their portfolio reducing. 

Couple A totally understand the different between investing in the business versus playing the stock market.  Indeed, they will often relate during discussions that they love this approach and cannot understand why others do not embrace it.  Couple 2, on the other hand, generally understand the concept and get excited about it (or the fact that they are involved with it) when markets are in a happy, buoyant phase.  They feel proud of the fact that they are taking some real action and investing for their future (fair enough). 

Couple A are much less inclined to feel ecstatic about booming trading prices and despondent about market pricing corrections.  Couple 2, when they get around to checking their investments, feel validated when they watch their portfolio rise but start to question their adviser and themselves when markets decline, as to whether or not they are doing the right thing.  They basically do not get it. 

MAY 2018

In May 2018, one of my clients decided they would cash up their portfolio and reposition into cash.  Their thinking was that, with all the negative sentiment around the market, there was likely to be a so-called ‘black swan’ event that they wanted to avoid and hopefully take advantage of.  In other words, they were looking to time the markets.

In my experience, it is usually unclear when such an event will strike.  The lead up to 2008 was one time when I was able to accurately suggest that there would be one of those events, which turned out to be correct.  To me, as early as 2003, it was clear. 

Fast forward to 2018 and in my view, the signals of a black swan event are anything but clear.  In other words, I could not see it then (May 2018) and I do not see it now.  Of course, I can always be wrong.

FEB. 2019

So, will the couple who have taken a strong bet against the market (cashing up and out of growth investments) be right?  

It is difficult to get into too much trouble sitting in cash, at least in the short term.  Longer term though it may not work out so well for them because cash and fixed interest are poor stores of long term wealth. 

One problem for them, is that It is highly unusual for most investors to buy growth investments when trading prices are under pressure and market sentiment is negative.  That behaviour (buying when markets are unhappy / scared) is counter-intuitive because humans are generally “wired up” for fight or flight, fear and greed.  Are they different?

Another challenge might be knowing when to get back into the market again.  

This might only take place after the market has lifted by 5% or 10%.  When they feel that things are …”safe”. 

If that is the case, not only have they had the expense of the brokerage to sell, plus the added cost of brokerage to get back in, but also the opportunity cost (late getting back in) of say 10% across the total value of the portfolio.  On a $500,000 portfolio that = $50,000.

Should an event cause the markets to “crash and burn” soon, then they could indeed be right and their exiting back in May will look highly intelligent.  The clock is ticking though …

People do buy and sell, taking big bets against the market.  It is just that there is minimal evidence showing that there are many who are successful timing the markets long term, especially when compared to just holding their original positions (assuming they were of suitable quality).

The other way to look intelligent and “worldly” long term is to invest as a business owner (avoid playing the stock market by trying to outsmart trading prices that are at the mercy of random market sentiment).

So how are they tracking?  The jury is out, even with the volatility from October 2018.  The problem they face is, the longer they stay out of the market, the more markets grow (regardless of the volatility in short term). 

Then, they at some point will be faced with having to catch up on lost “ground” (profits not made because they were out of the markets). 

The longer this goes on, the bigger the market crash they will need to make up for those lost profits.

Beating the markets by second guessing price movement is difficult at the best of times – especially with large amounts of capital.  If it worked once, chances are it won’t be easy to repeat at will.  Ask anyone who has invested over decades.

KISS

Have enough cash to average down … take advantage of lower prices … don’t get side-tracked by the markets … adhere to the investing strategy.

“Buy a business, don’t rent stocks.“

                                                              Warren Buffett