Jeff S. Vollmer interviewed about Closed-End Funds, and the role they can play in investor’s efforts at this point in the market cycle.
Investors love a contrarian idea. Though terrified of actually investing in such ideas, they love discussing them. Believing they’re “in the know.” Part of the smart money.
Discerning when such ideas have taken root? Easy. Everyone from clients, third cousins’ spouses and the local barista wish to discuss them.
“Hey, listen. I know some guys who have been buying up XYZ. Been really beaten down. Think it’s gonna go through the roof and soon. What ya’ think?”
Probably the most loaded question ever asked. Because distressed, beaten up contrarian plays will, eventually, rise again. But, the catalyst for such a move could be hours, days or years away.
Lately, everyone has been asking about commodity stocks. Because low prices have brought much attention to these cyclical plays. Oil. Corn. Uranium. Potash. Coal. Each of which have seen values decimated over the last six to twelve months. Time to buy?
Children love risk. They take risks for fun. Ding dong ditching the meanest neighbor. Ghost in the Grave Yard set in the blackest pitch of night. Lakeside cliff jumping. Sledding, full speed, through the trees, down the neighborhood’s steepest hill.
Natural-born risk takers, children. Possessing an innate sense of optimism, kids will inherently grasp at most anything that captures their fancy with little thought of downside.
Because their minds operate in the moment, children take great pleasure in the journey. The pursuit. The exertion of the exploration. There need be no other carrot. To children, risk is ample reward.
That changes with adulthood. Instead of gritting our teeth and going for the green, we choose to layup. Well, most do.
Some simply integrate risk into their lives as others may a law degree.
Austrian skydiver Felix Baumgartner broke the sound barrier by leaping from a helium balloon floating 24 miles above the earth. Trip Jennings became the first to kayak the notoriously turbulent lower Congo River. Jill Seaman spent decades bringing modern medicine to the world’s most war torn areas. Barrington Irving became the youngest person (and first African American) to fly solo around the world. Gerlinde Kaltenbrunner became the first woman to summit all 14 of the world’s 8,000-plus-meter peaks without supplemental oxygen. Jesse Livermore would leverage everything he owned in order to trade his way to a net worth of over $100 million in the early 1900s. Saddam Hussein defied the dire warnings of the western world and invaded Kuwait.
Racecar drivers. Surgeons. Despots. Entrepreneurs. Explorers. Post-50 mothers. Navy Seals. Sky divers. Maximum security prison guards. War correspondents. Circus performers. What do they have in common? Risk.
Their daily decisions are based upon the interplay between risk and reward. The rewards greatly differ. As do the levels of risk. Still, each regularly makes risk-calibrating decisions in pursuit of an end.
As children, we expose ourselves to risk for fun. The fun represents the reward. As adults, we take risks in the pursuit of goals.
With age comes a more measured, cautious approach. Our minds become burdened with responsibility. Our egos — weighed down by the emotional trauma of a few defeats — being opting for safer, more predictable outcomes. We begin considering our fallibility. Our inability to make up for life’s setbacks.
Risk becomes less fun. More intimidating.
In his seminal book on risk, Against the Gods: the Remarkable Story of Risk, Peter Bernstein provides a comprehensive history of man’s effort to undertake risk and probability. Gamblers in ancient Greece. 17th-century French mathematicians. Modern chaos theory. Drug testing. Bridge building. Wine making. And of course, investing.
Bernstein’s point? Everything entails risk. The acceptance of that caveat enables one to better manage, and thus benefit by, life’s inherent risks.
The art and science of investment management entails the near-perfect distillation of the risk-to-reward relationship. Because the accomplished investment manager’s sole objective is to attain the best risk-adjusted return available.
In 2000, and so again in 2008, many investors and investment manager’s lost sight of this responsibility. When things progress positively for extended periods, they often do. Lulled into a false sense of security, greater risk is taken in pursuit of greater returns. At such times, the markets usually teach investors and lazy investment advisors a harsh lesson.
The greatest risk? The students of such lessons learn nothing from them. And those that do not learn from history are doomed to repeat it.
Like wine and cheese, risk tolerance evolves with age.
At some point, we begin deferring on the risks required for achieving anything of historical significance. Opting instead for challenges that accompany that which is simply good enough.
My sons love to play the board game Risk. There may be no better means of teaching them the art and science of taking measured, calibrated risks.
One can achieve pure adulation by sending one’s legions from Venezuela into Central America, and with a few lucky rolls, end up controlling all of North America. Conversely, tears flow when one’s Napoleonic foray into Africa is soundly defeated on the planes of Congo.
Each turn, game and outcome holds lessons for their young minds. Cause and effect. Forethought. Strategy. Tactics. Deferral of immediate gratification in lieu of a greater goal. A ring-side look a the world-driving, history impacting relationship between risk and reward.
Whether your path is that of the arctic explorer or eighth grade teacher, risk acclimation is part and parcel of our lives.
Your morning meal. Your drive to work. Your relationships. Career choices. Professional licenses. Family planning. Geographic decisions. Schools. Social lives. Hobbies and habits. Friends and foes. Each entails countless interplays between risk and reward. From which your decisions will ultimately determine the direction and experience of your life.
So, why will some six-year olds try flips off the high dive, while others refuse to jump at all?
The neurotransmitter dopamine plays the primary role in one’s risk-orientation. Fewer auto receptors in the facet of the brain associated with reward (and addiction) brings a freer flow of dopamine. Which makes any risky behavior more satisfying. Causing one to take bigger risks.
Dopamine enhances your propensity to explore, discover, and challenge one’s self. It can lead to greater accomplishment, and greater loss.
It was dopamine that brought our ancestors to depart from the Rift Valley in East Africa 200,000 years ago, beginning a trans global quest for greener pastures. One that has never been satiated.
Dopamine catalyzed Louis and Clark’s westward expedition. Put a man on the moon. Helped men ascend to The White House. Climb Everest. And enabled you to confidently approach your spouse for the very first time.
More dopamine leads to less risk aversion. Plain and simple. Devoid of this natural neurotransmitter, we would still be drafting sketches on cave walls somewhere in East Africa. Anxious about the world around us.
And so there is no greater, more complex and less understood a relationship than that which exists between risk and reward.
Speculators have made and squandered fortunes on a hunch. Would-be entrepreneurs have condemned themselves to poverty, risking everything on one unappreciated idea. Political, business and athletic careers have been shattered as one strove to attain the elusive philosopher’s stone.
Mythology, history and literature are replete with this theme.
Gatsby risked everything trying to win Daisy’s heart.
Icarus flew too high and fell to earth.
Napoleon, risking everything at the Battle of Waterloo, was soundly defeated and exiled.
Everything worth attaining comes with risk. Our loves. Careers. Faiths. Families. Friends. Every foray and adventure upon which we endeavor will be accompanied by risk and reward. Without one, there is no other.
Remember what our 26th president, Teddy Roosevelt, said of risk.
“Far better it is to dare mighty things, to win glorious triumphs, even though checkered by failure, than to take rank with those poor spirits who neither enjoy much nor suffer much, because they live in the gray twilight that knows neither victory nor defeat.”
Risk too little, you run the risk of achieving nothing. Risk everything, however, and you risk having nothing. Therein that opaque and volatile equation lay the penultimate secret to satisfaction and achievement.
Wish I had the dopamine to figure it out.
Recently, I caught up with a friend who works in health insurance. Let’s call him John.
Last October, he explained, as the Affordable Care Act’s exchanges opened, John spent a lot of time speaking with those seeking insurance.
What he related was shocking. It wasn’t his opinion of the law. Its adoption rates. Nor the details.
What hit me like a cold breeze were the perceptions of those signing up. The dazzling lack of awareness. Not of the law. Most remain ignorant in that regard. It was the lack of basic knowledge. And common sense.
The point, he explained, was that he had to spend so much time not on the program’s intrinsics, but on basic terms and principles. For instance, words like subsidies. Deductibles. Premiums. As if John was speaking a foreign language.
Realizing that most people are not wordsmiths, I can’t help but believe that these are terms with which the average adult in the 1960s would have been familiar.
Go ahead. Chastise my insensitivity.
Yet, what I found unsettling was the larger idea. That so many Americans are ignorant in regards to basic principles, ideas, concepts and themes. In other words, if an idea is not within the vernacular of our popular entertainment outlets, with which we spend so much of our time, then we’re often ignorant to their existences, let alone their definitions.
Consider the anecdotal evidence:
-A recent Pew Survey found that 41 percent of Americans could not name the vice president.
-55 percent of Americans believe that Christianity was written into the constitution.
-30 percent of Americans could not recall the year of the 9/11 attacks.
-49 percent of young Americans could not find New York on a map.
-25 percent of Americans could not name the country from which we won our independence.
-30 percent did not know what the Holocaust was.
-And 20 percent believe that the sun revolves around the earth.
This nation, so intent on making all aspects of life easily and equally attainable, has eradicated much of the value we place on thoughtfulness, learning and critical thought.
America, contrary to every intent of the Founding Fathers, continues devolving into a nation of infantile, gratification-seeking spectators. More seriously, these tendencies have led us to increasingly place our faith behind politicians and policies of which we know little. Like children willing to walk anywhere, as long as our hands are being held.
At this rate, we’ll end up a Petri dish of simpletons, enabling the white-coated lab techs to do anything they please. So long as we’re comfortable.
That which we do prioritize? Phantograms of our own design. Simple, unimportant items to which we’ve artificially assigned great importance.
A “phantogram” is a type of optical illusion that makes a simple, two-dimensional object appear three dimensional. By distorting the perspective of the viewer, it causes him to see the object as having more depth and substance than really exists. A flat image, for instance, mimics the perspective of a multi-dimensional object when viewed from the intended vantage point.
Accordingly, our hyper-commercialized, consumer-oriented, media-driven, celebrity obsessed society casts a phantogramic perspective on facets of culture that, until recently, were not held in such esteem.
The victim of these national delusions of grandeur? Critical thinking and analysis at the individual level. Because, as a country, we no longer place a premium on critical thinking. Much of that which we once had to think through is served up on a platter by the Federal government. Like a herd of cow led to pasture. We don’t question, analyze or protest. We just graze.
Consuming is so much easier than questioning.
The “ready for consumption mentality” provides the recipient with tacit permission to forgo the heavy lifting. Be that physical, emotional or intellectual.
In 2008, Rick Shenkman published a book entitled, Just How Stupid Are We? Facing the Truth about the American Voter. Shenkman lays out four primary themes, among others.
First, he demonstrates how ignorant Americans are concerning international events. Second, he shows how little we know about the functioning of our own government. Third, we are usually willing to blindly accept government positions and policies even when a modicum of critical thinking would suggest that they’re bad for the nation. And finally, we are easily convinced of most anything by stereotyping, overly simplistic solutions, irrational fears and public relations babble.
Sounds like the average election cycle, right?
When life’s responsibilities are laid out before us like a Denny’s breakfast buffet, do we dull the ability to consider important aspects of our lives? Further, do we indemnify people against poor decision making, and the risks therein, by relieving them of the need to make such decisions?
What about our schools? Don’t they teach critical thinking?
Well, according to Dennis Bartels’s article in Scientific American, America’s schools are too busy preparing kids for standardized tests to teach such mundane skills as critical thought and analysis (article here).
Sadly, those poor teaching habits extend to the university level.
A recent NYU study underscored the idea that today’s university students do not receive the training necessary to develop critical thinking skills.
Over 2,200 students were part of the study. 45% made no improvement in their critical thinking skills during their first two years of college. After four years, 36 percent of students had made no improvements in their critical thinking abilities whatsoever. More here.
I might argue, however, that developing these skills in college is too late. Shouldn’t young Americans be taught how to think critically at the elementary, middle and high school levels?
Unfortunately, this is not a cultural priority. In fact, it seems that the American education system is predicated on the very idea of not challenging the system. Not speaking out. Not rocking the boat.
As opposed to training young Americans to digest differing arguments, diagnose the root issues, and make a decision, we train them on how to best prepare for standardized tests. Following those tests, instead of having developed a love of learning, deep thought and critical analysis, students immediately return to their brain candy addictions. Texting. Twitter. Facebook. Instagram. YouTube. Video games. ESPN. Nickelodeon. Netflix. Movies on demand. Sitcoms on DVR.
On that rare occasion when a student is confronted with two minutes down time, what usually escapes their mouths? “Iiii’m booored.”
But, they are bored. Because they exist in a world where our media-oriented culture provides entertainment like candy from a Pez dispenser. Readily available for immediate gratification. All day. Every day. Year round.
So, that occasional moment’s nothingness? It actually feels like hell.
Imagine a grossly overweight adult. He eats constantly. Then suddenly, he stops. Eats nothing. Two, three hours later? Serious withdraw. Ditto the drug addict. Long-time smoker. Alcoholic. Our kids are constantly consuming a steady diet of low-brow entertainment. When the well runs dry? Withdrawal hurts.
Regrettably, it’s not just our children. Adults increasingly default to a myriad means of immediate gratification, as well.
In 2012, Americans spent less time at work, volunteering and cooking. Yet, time spent on leisure activities (mostly TV) jumped to nearly five and a half hours a day.
Politicians seem especially intent on suppressing real critical analysis. On playing to the lowest common denominators.
Elections are won and lost on themes grounded in fear and emotion. Rarely do the major issues, disagreements and debates focus on hard data. Instead, it’s divisiveness. Fear mongering. Catering to our basest emotions. Sadly, it works. Slick advertising and communications efforts often carry charismatic candidates with little by way of substance, experience and vision into some of the nation’s highest offices.
Increasingly, it appears that we are obsessed with the pointless. With phantograms. In turn, we pay scant attention to the day’s most pressing issues.
So, when we are signing up for healthcare insurance, we may require some assistance. A explanation of some of the words.
r, we’re buying a home. The mortgage broker asks if we want that adjustable rate mortgage. With money back at closing. Umm, sure, why not?
Perhaps we’re considering that timeshare. Cheap vacations? Sounds great. Where do I sign?
Or Best Buy will sell you that huge flat screen. If you’ll sign up for their credit card. No money down the first year? Too good to be true!
Many of the routine decisions that our parents and grandparents methodically made? Today, we jump in with little forethought. Then look back upon them as if we were dealing in quantum physics when they don’t end well.
Ah hell, dude, all day long! Would BW3’s stock have risen 80 percent over the last year if Americans didn’t love to spend their time sitting around, drinking beer, eating wings, watching sports, and answering trivia questions on TV like,
How many spots did the 1001 Dalmatians have?
Today, we watch sports on weekends, as well as weekday evenings. We watch the pregame. The game. The post-game. Sports Center highlights. Check stats on ESPN.com. Follow the chatter on TheBigLead.com. Listen to the sports radio personality in the car. Listen to his podcast later that night. Read his book before bed. Our kids see this. And so, at an age where we just wanted to be Pete Rose, our children wake up to Sports Center. Spend their weeks practicing the three to five sports they play, year round. Spend their weekends traveling far and wide for game after game after game.
In between watching sports, we fill the empty space with celebrity gossip. Reality television. Video games. HBO. Showtime. ESPN. Fox Sports One. Bravo. The Cooking Network. The Hunting Network. The Fishing Network. CSPAN. GEAR TV. Spike. Cartoon Network. Netflix. Play Station. Gameboy. Style Network. Entertainment Tonight. The Real Housewives of Atlanta, New York, Orange County, Beverly Hills, and New Jersey.
We spend more time watching TV personalities perform our hobbies than we do engaging in them ourselves. And I haven’t even mentioned sex. Don’t have time to. I’ve got to finish this piece at some point this week!
Need further evidence of our inability to think critically? Our lack of focus on the issues that matter? Our government’s inability to contend with much of anything of importance? Allow these uniquely American statistics to gestate within the mind for a bit:
-The average American watches 1,800 hours of television each year. That’s five hours a day, 52 weeks per year.
-Nearly 30 percent of Americans have not read a book during the last year. Fifty percent have read one book. One book.
-116 million Americans watched the Super Bowl. That twice the viewership of the presidential debates.
-4 million viewers will catch tonight’s episode of The Real Housewives.
-2.1 million Americans married in 2013, yet at least half that number will divorce this year as well, saddling the U.S. with the highest divorce rate in the world by a wide margin.
-The U.S. has the highest rate of diagnoses for mental health disorders. Or, is it that we just have the largest appetite for the prescription drugs that accompany those disorders? Or, have we just gotten into the happen of calling every one of life’s challenges, a disorder?
-The debt carried by this year’s 167,000 college graduates will amount to over $200,000, more than they will make, in aggregate, over the next decade. That college debt just surpassed $1 trillion. Care to guess our economy’s next bubble?
-46 million of the 313 million people living in the United States are on food stamps, including one of every four children.
-The rate of teenage pregnancies in the U.S. is above 22 percent, 8 percentage points above New Zealand which has the second most.
-66 percent of Americans are considered overweight, yet the average American will still drink more than 600 sodas this year.
-The United States has a higher debt per capita than Greece, Portugal, Italy, Ireland and Spain combined.
-48 percent of Americans are considered low income or living in poverty.
-More than 25 million adult Americans live with their parents.
-One of every seven Americans has at least 10 credit cards.
-The United States puts a higher percentage of its population in prison than does any other nation.
-There are more unemployed workers in the United States than there are people living in the entire nation of Greece?
-Less than 65 percent of American men have jobs today, compared to over 80 percent in 1950.
Not a a pretty picture. Not if pride is one of the traits you admire.
If I told you there was a family in your neighborhood that fit a profile befitting most of the aforementioned statistics, how would you imagine that family? Would you envision them as a sharp, critically thinking bunch? Possessing proper priorities? Solid moral fiber? Would you let them watch your kids?
You absolutely would not.
At some point, perhaps we’ll recognize our phantograms for what they are – simple uni-dimensional distractions with which to bide a bit of free time.
Maybe we will return to placing a premium on personal knowledge, learning, growth and accountability. Enjoying the pleasure of succeeding independently. Of deferring immediate gratification in pursuit of a long-term goal. Of personally creating something original and unique.
One day, we may place a societal premium on personally experiencing the beauty, danger, tastes, sounds, feelings, highs and lows of this world, as opposed to watching an actor do it for us.
The philosopher Alan Watts said that the reason people want to go on and on is become we live in an impoverished present. Someday, perhaps we’ll exchange our phantograms for all of the wealth, beauty and joy the world can offer.
So long as the boredom does not kill you first.
Sunday marked the five year anniversary of the S&P 500’s nadir. March 9, 2009. The stock market bottomed out at 667. Representing the beginning of the end to the most extreme financial catastrophe mankind has ever seen.
There was little fanfare. Just another Sunday. Families attended church. Walked their dogs. Dined. Watched television. Read the paper.
Recall the state of affairs only five years ago. Then, the U.S. financial system teetered on extinction’s ugly precipice. Retirements were postponed. Families walked away from mortgages. Left keys in the mailbox. The bank’s problem now.
Jobs were lost. As was the ability to pay for tuition. Cars. Cable television. Food.
Anxiety levels rose. As did the suicide rate.
On that March day in 2009, the world seemed a volatile, chaotic and unfriendly place. Nor did it appear as if things would improve anytime soon.
To worsen matters, denizens of Main Street hardly understood what was causing the chaos. How could they? Wall Street’s grotesquely misshapen financial wizardry was largely beyond the pall. A confluence of ill-conceived financial engineering that, in aggregate, sparked a financial cataclysm.
Fannie Mae, Freddie Mac, lending money to anyone who could fog a mirror. Those “subprime” (read: less than desirable) loans were then bundled with decent and better-than-average loans and packaged into collateralized-debt obligations (CDOs).
Greedy, lazy financial institutions like Merrill Lynch loaded their balance sheets with these toxic instruments. Couldn’t help themselves. Nor did they know better.
In Michael Lewis’s boon on the financial crisis, The Big Short: How Wall Street Destroyed Main Street, hedge fund manager Steve Eisman explained Merrill’s role in the crisis as follows:
“We have a simple thesis,” Eisman explained. “There is going to be a calamity, and whenever there is a calamity, Merrill is there. When it came time to bankrupt Orange County with bad advice, Merrill was there. When the internet went bust, Merrill was there. Way back in the 1980s, when the first bond trader was let off his leash and lost hundreds of millions of dollars, Merrill was there to take the hit.” That was Eisman’s logic – the logic of Wall Street’s pecking order. Goldman Sachs was the big kid who ran the games in this neighborhood. Merrill Lynch was the little fat kid assigned the least pleasant roles, just happy to be a part of things.”
Yet, I digress.
As variable rate mortgages rose, homeowners were increasingly unable to pay. So, they began walking away. Leaving keys in the mailbox. Somebody else’s problem.
As loans began to default, those subprime strands of the CDOs quit paying. And as with any packaged financial instrument, if a one-percent facet of the instrument goes bad, the entire product becomes worthless. So, the prices of CDOs plummeted. Became illiquid. Toxic.
Next, FAS 157 instituted mark-to-market accounting in November 2007. All these banks had been happily collecting income from all these CDOs. Suddenly, nobody wanted them. They became illiquid. And FAS 157 forced institutions looking to sell any instrument to place a value on those instruments. Which was, essentially, zero. Billion of assets marked down to nothing.
Balance sheets were destroyed. Firms like Merrill Lynch which only the day before had been thoroughly addicted to the CDO’s easy income streams were now forced to unload them for 20 cents on the dollar. Which forced other banks to mark their CDOs at 20 cents. Causing further write downs. More chaos.
Eventually, mighty Merrill, now insolvent, was handed off to Bank of America in a government-arranged shotgun wedding.
Other firms, like Lehman Bros., were no more destitute than was Merrill Lynch. They were simply solvent longer. And so were too late to attract a suitor.
The destruction wrought by the ensuing collapse? Mythic. Millions of jobs lost. Thousands of companies eviscerated. Trillions of dollars in market capitalization, wiped out. 57 percent of the S&P 500’s value, gone.
Even today, with markets having risen 183 percent from the ’09 low, investors still quiver like wet Chihuahuas with each market decline. There remains a bit of post-traumatic stress disorder at work. Both on Wall Street, among those who caused the cataclysm, and on Main Street, which took the brunt of the blow.
In 2009, much of the populace believe that the U.S. was to be forever relegated to emerging market status. Never would the American economy gain back the wealth, jobs, GDP, optimism and opportunity lost within the swirling vortex that was the 2008 crisis.
Much of the so-called intelligentsia believed that 2008 marked the beginning of the end. The fall of Rome. The nexus at which the nation’s hubris, ambition, greed and innovation integrated in a lethal cocktail of cultural decimation.
And yet. Resilience has always been among the least understood attributes. It is not granted the lofty accolades of fellow adjectives like talent, genius, ambitious or focused. Yet, resilience generally outlasts them all.
Five years later, American GDP leads those of all major developed nations. Jobs are slowly returning. The domestic energy sector is flourishing. American social networking technologies are helping the world to communicate faster, cheaper and more effectively. Company IPOs have returned to Wall Street. And shoppers the world over are once again clamoring for U.S. retail technologies, clothing and consumer products.
The U.S. economy has not grown dramatically. Still, grown it has. When nobody thought it would.
Despite a frequent lack of leadership from both parties in D.C., the American people, led by the private sector, with an occasional assist from the public arena, have managed to rise from their knees, bloodied but unbowed. Having shaken off the dust and grime, the American worker has again shown what it means to be resilient in the face of seemingly insurmountable odds.
While stocks have climbed 183 percent off of the lows, achieving new highs following a 14-year consolidation, opportunities remain. This most hated of all bull markets continues to lack the frothy enthusiasm that generally marks an end. Investors continue to complain about the Fed’s stimulus programs. The surplus of paper money. Yet, the omnipresent liquidity poured into the global financial system not only served to assuage the massive global despair, but provided the springboard by which the S&P 500 might, according to some analysts, reach 3,330 before this bull ends. That’s five times the market low.
“But, we’re five years in? Ain’t this thing getting’ a bit long in the tooth?”
While the average bull market lasts five years and three months, there are three primary reasons as to why this cycle will differ.
First, the post-2008 recovery has been much slower than most. Credit-driven recession recoveries usually are. We expect the typical three percent GDP growth following such periods. This recovery took longer to heat up. Spent a protracted amount of time stuck between one and two percent GDP growth. Now, however, it appears that the expansion is finally getting some legs.
Second, there remains too much money on the sidelines. Or in bond funds. Largely a by-product of the post-traumatic stress harbored by a community of investors badly burnt twice in 13 years (2000-2002 and 2008). They will again be late to the party. When they arrive, however, it will extend the duration of the soiree.
Finally, the S&P 500 traipsed a 14-year consolidation period. Up, down, sideways. Ending up at in exactly the same position in March of 2000, October of 2007, and Q4 2013. Today, the index has pushed through that ceiling. Traditionally, when stocks or indexes break through a ceiling that had contained them in a trading range, they propel much higher before coming to a halt.
While there will inevitably be pullbacks, some large and scary, participating investors have grit their teeth and pushed through every dilemma these last five years.
Without the participation of many Main Street investors. Devoid of the assistance of many on Wall Street. Investors, believing in the resilience of the market, have reaped the rewards.
Nor did the American worker ever fly the white flag. Throughout the harsh economic circumstances of the last half decade, Americans remained resolute. Woke early. Worked hard. Day in, day out. Catalyzing a domestic manufacturing renaissance. An energy boom. And the rebirth of our technology, healthcare and banking sectors, just to name a few.
Due to the resilience of our economic system and workforce, our domestic economic landscape now appears to be back in a position of strength. Despite the faults and foibles of our political system and those operating therein. Despite the harsh vituperations of critics. Despite the inevitable environmental and geopolitical trauma with which we will always contend.
“The human animal will keep behaving the way it has in the past,” Warren Buffett has said. “We will have periodic recessions and occasional panic but the good news is in the 20th century, we had two world wars, the flu epidemic, the Cold War, atom bomb, you name it. And the Dow Jones went from 66 to 11,497. All these terrible things happened, but America works.”
The future of this nation? Shame on those who doubted it. Do not let the occasional clumsiness of her leadership cast any doubt on one crystalline, cast-iron fact:
Five years after rock bottom, though unfinished the journey remains, we’re back, baby.
In 1797, Napoleon Bonaparte had just returned to Paris following a successful Italian campaign. Having kicked butt and taken names, Napoleon was an overnight celebrity. A conquering hero. A man of letters, wealth and distinction.
Immediately, he was commissioned to invade England. Napoleon, the master tactician, persuaded his bosses that an incursion against English assets in North Africa, specifically Malta and Egypt, would be more successful.
Financed by Swiss gold, young Bonaparte sent twenty one demi-brigades and 300 ships to war.
Having eluded the Royal Navy, the French overcame Malta and landed in Alexandria, Egypt, on a sultry July afternoon. It take them long to occupy the entire country. Napoleon entered Cairo three weeks later.
The French busied themselves establishing printing plants. Creating the Institute of Egypt, where they organized the country’s scholars under the monikers of mathematics, physics, political economy, literature and arts. They built hospitals. Improved sanitary conditions and reduced epidemics. Citizens were disarmed. Streetlights installed. And, of course, taxes reinstated.
Among the many archaeological interests the French pursued, one in particular was key to unlocking the trove of Egyptian intellectual treasures.
The Rosetta Stone, named after the village in which it was found, measured roughly four feet by two-and-a-half feet, was eleven inches thick, and weighed nearly a ton.
The stone was covered in inscriptions for three languages. Greek. Egyptian. And Demotic, an ancient Egyptian text derived from Hieroglyphs and dating back to 643 B.C.
While the first two languages were easily deciphered, the Demotic was, well, Greek to them. Entirely untranslatable. And with so many of Egypt’s ancient secrets ciphered in this ancient text, its translation was critical.
In 1822, 23 years after its discovery, a French scholar translated the stone’s Hieroglyphic inscriptions and unlocked the secrets of Egypt. Science. Mathematics. Literature. And more. All begotten by the discovery and translation of the Rosetta Stone.
Of course, Napoleon had long ago returned to France. Lacking his talent for ass-kicking, leadership and municipal management, his predecessors had not exactly improved upon what he left. In fact, Egypt had been largely cut of from France by the English and Turks. Whom, working in concern, laid siege to Alexandria, expelled the French and claimed their booty. Another story, entirely.
The point? In discovering the Rosetta Stone, and unlocking its code, the French, English and Turks were able to reveal a trove of ancient logic, knowledge and truth.
Consider the failure of most investors to achieve anything resembling their goals. Investors, both individual and institutional, too often find themselves chasing a Holy Grail, as opposed to working out the codes of their individual financial autonomy. Assuming too much risk in pursuit of fleeting treasure. Vacating any real chance of achieving peace of mind.
While there are a myriad of heuristics used by successful investors, there is one secret that, if used systematically, can lead to consistent, market-beating returns.
That Rosetta Stone for investors? Capital efficient businesses.
Warren Buffett, one of the richest men in the world, earned his entire fortune by investing in capital efficient companies. Had you invested $10,000 with Buffett in 1956, and left it to his value-driven methodology through 2007, your $10,000 would have become $366 million.
Buffett’s secret? Capital efficiency. Investing in companies possessing unusually high returns on net tangible assets (book value). Employing maximum capital efficiency, even in the face of well-financed competition. Forgoing large and reoccurring capital expenditures. Providing investors with sustainable, unusually high returns on assets, and returning excess capital to investors.
Galileo’s epiphany began with an apple falling upon his head. So awakening him to the ideas already stirring his imagination.
Us? No such moment. Nor do we take credit for any original thinking on this topic. Many investors having employed this Rosetta Stone for years, having made a lot of money.
Still, I’ve one point to make.
In my decade-plus spent with Smith Barney (now Morgan Stanley), not to mention the aggregate years my colleagues spent with Merrill Lynch, UBS and Morgan Stanley, never did we hear the term “capital efficiency” employed within those brokerage offices. Not once.
The only sure-fire means of enabling one to glean market beating returns, practiced by some of history’s most renown investment luminaries — Warren Buffett, Benjamin Graham, Seth Klarman, Walter Schloss, Irving Kahn and Peter Lynch. And in our more than fifty aggregate years spent within the nation’s largest brokerage firms, never was this Rosetta Stone even whispered.
No wonder we are in such dire retirement straights.
Were the brokerage firms’ advisors-cum-salesmen to begin worrying about the tenets of fundamental analysis, like capital efficiency ratios, it would degrade from their attention to selling and gathering more assets. The primary concern of our publicly traded financial behemoths.
Recently, Morgan Stanley reported record quarterly profits (here). Largely on the back of its wealth management unit. When the world’s largest wealth management business, working with Main Street’s retirement capital, reports record profits and with plans to improve upon that next quarter, there is a fundamental problem. Not to mention a glaring conflict of interest.
Though the Rosetta Stone of investing is not part of their playbook. But it should be part of yours.
Find companies that possess outrageously high returns on net tangible assets. Whose management teams are committed to returning excess capital to shareholders. Do so consistently, for the long run, and you will always make money in stocks.
Like drunken sailors on shore leave, markets fell for a second straight week. Friday in particular saw the Dow drop nearly 2 percent. It now looks oversold.
Interesting to watch markets rage over bond and currency declines in emerging markets, particularly Argentina, after major credit crises in major European markets like Italy and Spain failed to derail them these last three years.
Meanwhile, the world’s richest and most powerful have gathered in Davos. Private planes. Limos. Skiing. Full-body fur coats. Private chefs. And $26,000 bottles of Cristal. All, so that the world’s top 0.00000000001% can discuss a more effective means by which your life might be run. For Jon Stewart’s ever-humorous take on this hubris festival, click here.
Heard of the Salem Witch Hunt? What about the Satanic-mania of the 1980s?
In the 1980s, amidst the backdrop of Ronald Reagan, Pac Man and Michael Jackson, America witnessed a virulent moral panic involving alleged satanic ritualistic abuse against children.
Ever wonder how a witch hunt begins?
Seemingly random incidents were linked by organizations on the lookout for bizarre societal behaviors. Soon, concerned citizens spoke in hushed tones of apparent satanic influences.
Suddenly, word spread of a conspiracy involving the dark arts and the nation’s traditional child care system. Rumors of child abuse gave way to allegations against traditional caregivers: Teachers. Preschools. Nursery schools. Daycare centers. Babysitters.
Soon, the fires of controversy burned across much of the United States. Criminal investigations were underway. Talk shows, parental and religious organizations fanned the flames. Told of a worldwide conspiracy pitting the forces of evil against American children.
A modern-day witch hunt. In 1980s America.
Eventually, investigations produced nothing. No conspiracy. No slaughter of innocents. No crimes involving devil worship and children.
Soon enough, the matter dissipated into the ethosphere of yesterday’s news. Though, not in time to prevent the destruction of individual reputations and careers.
A modern-era witch hunt involving demons and children. Allegations of a conspiracy to carry out ritualistic abuse under the watchful eyes of a modern society. Innocent lives, destroyed. 322 years following the Witch Trials of Salem, Massachusetts.
Just another extraordinary popular delusion spawned by the madness of crowds.
For the attentive, the event reaffirmed valuable lessons concerning the lethal potential of groupthink. That fact that an idea can evolve into mass hysteria. Can lead to the depths of darkness. Long before the truth comes to light.
Conformity. Groupthink. Convention. Herd mentality. Regardless of the moniker, the attributes of interdependent thinking can poison a free society. Stifle creativity. Stunt critical thought. Incite enthusiasm for the most demented of causes and crusades.
William Safire discussed these traits in his “On Language” column in 2004. Safire referenced William H. Whyte Jr.’s creation of the term “groupthink” in a 1952 Fortune magazine article. Whyte, the author of The Organization Man, lamented the “rationalized conformity” which, he reasoned, had become the “national philosophy.”
By example, Whyte bemoaned the orthodoxy that had become justified through conventions deemed efficient, acceptable and good.
Two decades later, Irving Janis wrote Victims of Groupthink, in which he pondered how groups create pressures so that “the members’ striving for unanimity overcome their motivation to realistically appraise alternative courses of action.”
History reveals that, as groupthink and conformity take hold, so develops a vicious circle: the more cohesion, the more pressure toward “rationalized conformity.” With more conformity comes more cohesion. Outsiders, and their ideas, are shunned. Everybody adheres to the same chorus. Unique perspectives and original thoughts are crushed. Individualism is deferred for the good of the whole. Before long, homogenized means of thinking bring the most ill-conceived ideas rapid and unanimous acceptance.
Voila. A witch hunt. In 1980s America. Yet, should not our open-minded, democratic society be an antidote for such madness?
Or could it be, in fact, the opposite.
Our societal paradigm, with its propensity for labels, brands and memberships, seems hell bent on fomenting groupthink at the juncture of every decision tree.
This begs the philosophical question: is society smarter in sum, or in its individual parts?
Henry David Thoreau lamented upon the issue, saying “The mass never comes up to the standard of its best member, but on the contrary degrades itself to a level with the lowest.”
Of course, Thoreau was a rabid individualist. What about really effective groups. Like our democratic government?
As a democracy, the United States has long prided itself on the ability to collectively discern its future path. As well as its most effective political leadership.
Yet, critics argue that a democratic means of government simply enables the crowd to cast votes for those promising the most benefit to the widest swaths of the electorate. Regardless of the substance behind such promises.
Gustave Le Bon was such a critic.
In 1895, Le Bon published his polemical classic The Crowd: A Study of the Popular Mind. Appalled by the rise of democracy in Western society, Le Bon was equally dismayed by the idea that ordinary people had come to wield such political and cultural power.
Accepting that Le Bon was likely a pompous, aristocratic windbag, his argument merits analysis.
A crowd, he explained, is more than the sum of its members. In fact, it is an independent organism possessing an identity and will of its own. As such, a crowd will often act in ways that no individual member of the crowd intended. And when it does act, it invariably acts foolishly.
Le Bon felt that a crowd could be cowardly, or cruel, but could never be smart. As crowds can never accomplish anything demanding a high degree of focus, direction or intelligence, crowds are always intellectually inferior to the individual.
Le Bon’s idea of the crowd encompassed the obvious examples of collective savagery, like rioters, lynch mobs and the Nazi party. But also included just about any group of decision makers.
How could a young son of Dachau join the German military in 1939 and so readily accept his responsibilities at the camp to which he was assigned?
Consider the words of Friedrich Nietzsche, of whom Hitler was a devotee, who wrote, “Madness is the exception in individuals but the rule in groups.”
Nietzsche believed that as individuals, man possess the opportunity for greatness. He also felt, however, that collective reasoning — that is, groupthink — had the propensity to dull man’s senses. Stifle man’s aptitude for achievement. Lead him to places he may not have individually strode.
Of course, modern scholars, naturalists and biologist will opine on the power of groupthink throughout the natural world. But, there too we find refutations to mainstream thought.
Take ant colonies. Long held out as mother nature’s supreme example of the power of collective action and achievement, recent studies reveal otherwise.
Takao Sasaki and Stephen Pratt from Arizona State University found one such example in their study of house-hunting Temnothorax ants.
While the researches had previously believed that the colony was collectively more capable of choosing the best living locations, their findings showed that this only happens if the options are similar. It one potential nest site is clearly better, individual ants tended to make better decisions than did the colony. Read more here.
If on occasion, we have misread ants, then what about ourselves?
This underscores an important theme for investors. Not to mention decision makers of all disciplines.
That is, if ants, in their non-emotional, performance-based hierarchical systems can commit collective errors in which the crowd’s wisdom devolves into foolishness, then what of homo sapiens? What of our emotionally charged, fear- and greed-based means of decision making? To what types of errors might we susceptible?
Well, when it comes to groupthink, let history be your guide.
Financial manias. Racism. Anti-Semitism. Misogyny. Xenophobia. Nationalism. War. Fanaticism. Fundamentalism. And witch hunts. 322 years apart. Just to name a few.
In the name of race, nationality and religion, human beings have begun an innumerable variety of ill-conceived crusades intended to benefit whatever collective from which it may have originated.
We continue to elect and re-elect politicians who, aside from a talent for personal enrichment, have failed in providing any other attributes proven to elevate the plight of their constituents. Yet, any charismatic individual with a quick tongue, deep pockets and moxy can step into national office and set the agenda. And our opinions.
Suddenly, one understands how investors so quickly buy into any sales pitch. Any potential moon shot. Any get-rich-today scheme. Regardless of rationale, logic or methodology.
History remains littered with the scarred remnants of groupthink. The South-Sea Bubble. Tulip Mania. The Crusades. Witch Hunts. Fascism. Nazism. Totalitarianism. Fundamentalism. The Cabbage Patch Dolls. Boy Bands. Tech Bubble. The Housing Bubble. Washington D.C. and most of its inhabitants.
We stumble from one collective mania to the next. Driven by fear and greed. Catalyzed by the herd mentality. Driven by a hunger for ruin that prevents us from seeing the forest for the trees. Until its burning around us.
“Men, it has been well said, think in herds,” wrote Charles Mackay, author of Extraordinary Popular Delusions and the Madness of Crowds. It will be seen that they go mad in herds, while they only recover their senses slowly and one by one.”
So it goes with investors. Afire with the fever of each passing mania. Hungrily reaching for wisps of smoke that barely exist. Or running, en masse, from the illusory demons of our financial demise. Demons that exist only in our collective psyches. Manufactured by our deepest insecurities. Magnified by the popular media.
So long as investors tune into the ill-conceived collective narrative, they will continue to act like anxious cows, flicking their nervous heads to and fro. Running from imaginary predators. Until, chasing the herd, they find themselves singularly vulnerable. Incapable of acting alone. Fixated on the approaching headlights.
Wake up, America.