Juggling Dynamite

GMO’s December letter The Late Cycle Lament is a must read for anyone with savings they would like to keep and grow going forward.  There are many excellent charts and clear-eyed insights on the present state of equity valuations, probable price paths and the capital-destructive myopia of most financial advisors and managers.  You can read the whole thing here, the closing quote offers a summation:

“…most black swans in finance/investing are really “predictable surprises” to borrow Max Bazerman’s term (yes, I know that sounds like an oxymoron). Predictable surprises are characterised by three features: 1) at least some people are aware of them; 2) they get worse over time; and 3) they eventually explode into a crisis.

You might ponder why people are so bad at spotting predictable surprises. It turns out there is a plethora of psychological and institutional impediments. Two we have already met at the outset of this essay, overoptimism and overconfidence. They are aided by myopia – an overt focus on the short term – born of the institutional imperative to perform at all-time horizons; or its cousin, the relative performance derby; or simply a function of the human brain. Motivated reasoning plays a part as well. As Warren Buffett put it, “Never ask a barber if you need a haircut.” It is hard to get many finance professionals to think about the possibility of a crash when their employment and income depends upon that event not happening. Also noteworthy is inattention blindness…put simply, we just don’t expect to see the things we aren’t looking for…

Having read this entire essay, perhaps you believe one of the conditions I laid out earlier (in terms of P/E, ROC, or growth). If not, you are probably skeptical about the ability of the U.S. market to continue its outstanding performance. Ask yourself how much exposure you have to the U.S. stock market. Then ask yourself what is the minimum amount you could own. We at GMO own essentially zero in our unconstrained portfolios, but then again we are used to career risk and would rather run it than allocate to such an expensive asset.

 

 

Danielle was a guest on The Financial Survival Network with Kerry Lutz, talking about recent developments in the world economy and markets.  You can listen to audio clip of the segment here.

Over the latest upcycle starting in 2009, we have noted that participants were increasingly value-indiscriminate, trend-chasers, buying–not based on security analysis or investment prospects–but because prices were going up.

Indeed, recent data confirm that some 85% of trading volume in the past few years has come from computer-driven models, high-frequency traders, so-called ‘market makers’, passive funds and indices.  This mindless game of follow-the-leader has grown bigger and more leveraged this cycle than ever before in history.  To many, it looked brilliant as prices rose far above rational metrics, but few are prepared for the other side of the bargain: indiscriminate selling where prices fall far below rational metrics, and often labor there for years to come.  See Behind the Market Swoon:  The Herd-Like Behavior of Computerized Trading.

Tragically, in the midst of today’s capital roulette games are mom and pop participants –with real life, time-sensitive needs like housing, education and retirement funds–who are counselled and enticed to ‘buy and hold’ at every price on the way up, and ‘stay the course’ as prices plunge and the herd tramples over them.  This is a highly inefficient, devastating strategy for individuals with finite time-horizons.  It is also entirely unnecessary.

We do not need to speculate with our life savings–blindly follow the masses– to reach our financial goals. Indeed, the odds of achieving and maintaining strength and stability while doing so, are nearly nil.  The biggest part of financial strength comes from careful income and expense management, regular savings plans and debt avoidance.  Investing well is part of prudent financial management, but it requires personal discipline and careful rules about when and how much of our principle is allocated where, and for how long.

Today is an excellent time to break away from the madness of crowds and mindfully define a more secure path to your goals.  If you would like some help to get started or a review of where you are at, send me an email outlining your circumstances, and I will offer my thoughts and suggestions — happy New Year.