Regular readers of this blog will know that many of my posts are sparked by books or articles I've read. I thought it might be helpful to put together a short list of things I particularly enjoyed in 2014. While I've restricted the list to things I read for the first time in 2014, it must be said that I vastly prefer reading old classics to newer but less memorable tomes. I recently decided to pack up roughly 1/3 of the books that I own since I saw very little likelihood I would re-read them in the next 24 months. Of the remaining 2/3, I estimate I have yet to read 40% of the titles - but I'll get there! Still, there's no way to discover new favourites without breaking some new ground, so here's the 2014 list.
Business, Finance & Economics
Creativity, Inc: Pixar's Ed Catmull recounts how the company was built. An enjoyable look at the origins of this path-breaking company, and also very informative in thinking about how creative organizations can be nurtured. I wrote about it here.
Salt Sugar Fat: Part history of the food industry, part expose of its unseemly practices to hook us on unhealthy foods. Like Jonathan Safran Foer's "Eating Animals", it truly changed how I view food and how I eat. It also made me think hard about equally unethical practices in the financial services industry.
The Second Machine Age: MIT professors Brynjolfsson and McAfee follow on from their previous work describing how technology is changing our economy, and how it will affect us as consumers, producers and workers. One of the greatest challenges is avoiding "this time is different" thinking while appreciating when genuine secular change is in the works. 2MA raises as many questions as it provides answers.
Conspiracy of Fools: The story of Enron's rise and fall is well-known, but this account reads just like a thriller. The combination of greed, corruption, stupidity and fear of standing out is breathtaking, as is the juicy array of characters.
The Rotten Heart of Europe: Regular readers will know I'm often bearish and sometimes just plain confused about the future of the Eurozone. Connolly's book talks mainly about the cracks that were visible in the European project well before the European Exchange Rate Mechanism came to pass (predating the ongoing Euro crisis). Remarkably prescient about the crisis, and skillful in describing the politics and economics behind the flawed idea. I wrote about it here.
And The Money Kept Rolling In (And Out): I'm a huge fan of Paul Blustein's work, and this work on the collapse of Argentina in the early 2000s is as good as I'd expect from him. It was particularly pertinent in 2014 as Argentina's sovereign debt woes continued, a legacy of the era Blustein recounts so skillfully.
The Life You Can Save & The Great Escape: It may surprise some to see Singer's "The Life You Can Save" under the Business, Finance & Economics heading but dealing with poverty is obviously an economic issue as much as a moral one. Singer's book will appeal to those who want to think clearly about how to do the most good with limited time and resources, and resonated deeply as I considered my long-term financial and life priorities. However, I disagreed with Singer's mechanical view of the economy where simple redistributions from rich to poor would create the best outcomes. This is a theme Princeton professor Angus Deaton takes up in "The Great Escape", which is a superb account of global trends in health and material well-being. Despite what appears to be a left-leaning bias, he is tepid on foreign aid and external intervention. Empathy has to be tempered with the fact that a true "Great Escape" can only occur when countries have strong organic institutions to engender postive health and economic outcomes.
Pioneering Portfolio Management: David Swensen's shepherding of the Yale endowment is the gold standard in institutional investing. Here, he describes how Yale does what it does (and doesn't shy away from attacking foolish and unethical practices in the financial industry). Of course, it must be taken with a grain of salt since not all institutions have Yale's resources and clout.
Measuring The Moat: Not a full-length book, but I loved the way Maubossin and Callahan combined a deep understanding of strategy and finance in this piece to explain how companies produce returns. This should be required reading for management and investment professionals alike.
Others
Make It Stick: I'm always trying to learn about learning, and this book is absolutely terrific. I gained so much from the authors' explanations of the science of learning, which is conveyed in an accessible and memorable manner. Keeping this blog going is, in part, a reflection of some of the lessons learned from this book.
The Great Agnostic: Susan Jacoby does a superb job in bringing Robert G. Ingersoll back to the forefront of American intellectual history. Ingersoll's writing and speeches are magnificent to behold, but what's most impressive is how a contrarian streak and devotion to truth led him to the right side of many issues before his contemporaries.
Naked Statistics: If you're like me and have forgotten quite a bit of what you learned in high school/college statistics courses, Whelan's book, focusing on the intuition behind statistical thinking, is for you. We live in a world inundated with data and "statistics", so this is helpful in trying to separate fact from fiction. Whelan's humourous and accessible style had me laughing throughout - no mean feat for a book on statistics.
Hunting Eichmann: Fascinated by WWII? Of course you are. My interest was reignited after a trip to Auschwitz this year, and the story of Adolf Eichmann was particularly compelling. One of the central figures in conducting the Holocaust, Eichmann eluded capture for 15 years before being kidnapped by the Mossad in Buenos Aires. I learned a lot about the history of modern Israel, as well as Argentina's status as a Nazi haven post-WWII.
Marked: I have long been interested in the issue of returning formerly incarcerated people to the workforce, but Devah Pager's superb and creative sociological study reveals the challenges this group faces. Prepare to be shocked at the magnitude of this problem.
On China: I had this book on my shelf for 2 years before finally getting to it, and truth be told, may never read this massive tome again. But Kissinger's history of China, with a focus on foreign policy, is quite fascinating. Today, we take China's rise as a given but it's always worth remembering the domestic and international political environment necessary to allow those far-reaching economic reforms to unfold.
In the Buddha's Words: "Mindfulness" is all the rage in the West these days, but this anthology compiles the Buddha's original teachings from the Pali Canon in a thematic fashion. It seems only right that we should seek truth wherever it may be found, and the power of these teachings resonated deeply with me as a secular humanist (as opposed to a "religious" Buddhist). Naturally, I managed to connect these ideas to investing here.
Honourable Mention
The Euro Crisis and Its Aftermath: If you need a primer on the Euro crisis, Jean Pisani-Ferry has done a terrific job here.
Beyond Debt: Similarly, Nikos Tsafos has done a good job bringing together the various strands of the Greek crisis in a single volume.
Risk Savvy: I'm a big fan of Gigerenzer's work. I'd heard much of this in prior books and speeches, but he always challenges me to go against some of the biases I hold, and to try and think more clearly about risks.
The Masters of Private Equity and Venture Capital: I read this in preparation for doing some consulting work to the PE industry, and enjoyed the easy style of the interviews, along with a good introduction to how some of the industry's top minds think. I wrote about it here.
There's Always Something to Do: This is a short and enjoyable biography of the Canadian value investor Peter Cundill. While short on the nitty-gritty of specific investments, there is enough here to entertain students of the value investing niche. I wrote about it here.
The Fall of the Celtic Tiger: I'm sure you've figured out by now that I'm fascinated by financial & economic booms and busts. Ireland's particular foray into this genre is explained well by Donovan and Murphy. I wrote about it here.
The Accidental President of Brazil: I really enjoyed these memoirs of Fernando Henrique Cardoso, who should be credited with Brazil's recent rise to prominence (a legacy his successors seem intent on squandering, unfortunately). The only reason this didn't make it to the main list is that I only read selected bits on Brazil's defeat of hyperinflation. I'm sure I'll read the whole thing at some point. I wrote about it here, here and here.
Man's Search For Meaning: This is partially a memoir of psychologist Viktor Frankl's time in Nazi concentration camps, and partially a discourse on his system of logotherapy, which proposes that the primary motivational force of an individual is to find meaning. I read this just before visiting Auschwitz and was deeply moved.
Monday, January 12, 2015
Tuesday, December 30, 2014
Some Advice For The Real Asset Owners
Much of what I write on this blog is targeted at fellow investment professionals. But it's never far from my mind that our ultimate clients are people who entrust us with the important task of safeguarding and growing their wealth. It bothers me that the asset management industry has started to refer to pension and endowment CIOs as asset owners. Most CIOs are just intermediaries. The real asset owners are the communities and members they serve. So while I don't spend an awful lot of time writing for the retail investor, I recognize that it's a worthy task, and I'm always impressed when someone does it clearly and honestly. A good friend recently asked me how he should be investing his money, and I thought a blog post would be helpful given his impending foray into the married life.
1) Understand the nature of financial assets. Financial assets provide streams of cash that are returned to investors at different points in time. We invest today, hoping to gain a return at some future time. There is a baffling array of financial instruments out there, of which stocks, bonds and real estate are the most common. But thinking about assets as streams of cash helps remove some of the poor thinking that often clouds personal finance. For example, a share of a company is a small claim on the company's future profits, not just a symbol on a stock exchange that miraculously goes up or down.
2) Understand the time value of money. A dollar today is almost always worth more than a dollar tomorrow because of the effects of inflation and the opportunity cost of postponing consumption. When thinking about future streams of cash, we must take this into account. It is the discounted cash flows we care about (i.e. cash flows measured in today's money), not the total cash flows. That said, investing for the long term allows us to harness the power of compounding, which helps small initial sums grow faster than we might expect.
3) Understand valuation. Thinking clearly about the nature of financial assets and the time value of money helps to provide a rudimentary framework for understanding how these assets are valued in a market. It's not uncommon to hear a naive investor say something like "I'm investing in Chinese equities because it's a fast growing economy" or "I'm invested in Apple shares because their iPhone sales are growing rapidly." Even if growth is strong, the market is already pricing in some expectations about future growth rates, profits etc. Always ask yourself, "What are other market participants pricing in?"
4) Understand cycles. Markets facilitate exchange between humans, so it's unsurprising that individual cognitive biases or broad social forces can move market prices to extremes, untethered from reality. We've seen this over and over in financial history. But these cycles present investors significant opportunities if they can strike a middle ground and retain a sense of equanimity.
5) Appreciate uncertainty & randomness. The world is a complex, inter-connected place. Financial markets are inherently volatile and unpredictable, reflecting investor psychology, industry dynamics and macroeconomic policy, among others. Unfortunately, charlatans are only too willing to claim special foresight and skill. Be skeptical of the stories people tell to explain events or their own performance.
6) Understand risk. Given cycles, uncertainty and randomness, outcomes can offer differ sharply from expectations. An appropriate investing framework should give due consideration to the fact that (a) interim fluctuations can be disconcerting, and (b) sometimes even the savviest investors are just plain wrong. Furthermore, all other things being equal, a riskier asset should be cheaper than a less risky one. This is an essential input into valuation, reflected by the discount rate (i.e. how much a future cash flow is valued in today's money).
7) Investing doesn't need to be a DIY process. But if you're hiring someone, do it right. Any adviser worth his or her salt should demonstrate a keen appreciation of the factors I've listed above. I've written several posts on the characteristics of good investors (see here, here and here, for starters). Also, meet several advisers to get a sense of pricing. It may be worth it to pony up for a skilled adviser or fund manager, but don't forget that small differences in expenses and fees add up to big bucks over the long term through the power of compounding.
8) Ask advisers how they invest personally. Any fund manager should have a sizable portion of his net worth in his own fund. A financial adviser should similarly broadly follow the tenets he espouses for his clients. If a financial adviser has a markedly different asset allocation than the one he's proposed for you, then you should be asking some hard questions.
9) Challenge your adviser, but don't make unrealistic demands. Randomness means that short-term performance says little about an adviser's skill. Furthermore, there are times when it is entirely appropriate for your adviser to underperform a benchmark. For example, if financial markets are entering uncomfortably overvalued territory (based on logical, rational metrics, rather than just story-telling), a courageous and ethical fund manager or adviser may well underperform. Conversely, if an adviser or fund manager is suggesting things that you simply don't understand, it's ok to walk away. Perhaps you won't maximize your returns, but you'll hopefully avoid catastrophes and outright fraud.
10) "Gain all you can, save all you can, give all you can." John D. Rockefeller was reportedly a fan of this dictum, typically attributed to John Wesley. While reasonable people can disagree about what constitutes "all you can", the pithy saying holds some hard truths. The process of saving and investing isn't rocket science, but it requires discipline and a willingness to ignore the social pressure of over-spending. A healthy attitude to money is cultivated through conversations with financial professionals, but even more importantly by developing a sensible world-view that recognizes the limits of material well-being. There's no doubt that we have long-term savings goals such as kids' college tuition and health care in old age to save for. But many of us will be fortunate enough to contribute to worthy causes such as fighting childhood malnutrition and disease, or building educational and health institutions in impoverished countries. In a classic case of obliquity, we are likely to be better investors by not focusing excessively on our material well-being, and accepting the uncertainty that investing brings.
I wish you all a healthy, happy 2015 (even if that's too short a period to accurately assess your well-being, not to mention investment performance).
1) Understand the nature of financial assets. Financial assets provide streams of cash that are returned to investors at different points in time. We invest today, hoping to gain a return at some future time. There is a baffling array of financial instruments out there, of which stocks, bonds and real estate are the most common. But thinking about assets as streams of cash helps remove some of the poor thinking that often clouds personal finance. For example, a share of a company is a small claim on the company's future profits, not just a symbol on a stock exchange that miraculously goes up or down.
2) Understand the time value of money. A dollar today is almost always worth more than a dollar tomorrow because of the effects of inflation and the opportunity cost of postponing consumption. When thinking about future streams of cash, we must take this into account. It is the discounted cash flows we care about (i.e. cash flows measured in today's money), not the total cash flows. That said, investing for the long term allows us to harness the power of compounding, which helps small initial sums grow faster than we might expect.
3) Understand valuation. Thinking clearly about the nature of financial assets and the time value of money helps to provide a rudimentary framework for understanding how these assets are valued in a market. It's not uncommon to hear a naive investor say something like "I'm investing in Chinese equities because it's a fast growing economy" or "I'm invested in Apple shares because their iPhone sales are growing rapidly." Even if growth is strong, the market is already pricing in some expectations about future growth rates, profits etc. Always ask yourself, "What are other market participants pricing in?"
4) Understand cycles. Markets facilitate exchange between humans, so it's unsurprising that individual cognitive biases or broad social forces can move market prices to extremes, untethered from reality. We've seen this over and over in financial history. But these cycles present investors significant opportunities if they can strike a middle ground and retain a sense of equanimity.
5) Appreciate uncertainty & randomness. The world is a complex, inter-connected place. Financial markets are inherently volatile and unpredictable, reflecting investor psychology, industry dynamics and macroeconomic policy, among others. Unfortunately, charlatans are only too willing to claim special foresight and skill. Be skeptical of the stories people tell to explain events or their own performance.
6) Understand risk. Given cycles, uncertainty and randomness, outcomes can offer differ sharply from expectations. An appropriate investing framework should give due consideration to the fact that (a) interim fluctuations can be disconcerting, and (b) sometimes even the savviest investors are just plain wrong. Furthermore, all other things being equal, a riskier asset should be cheaper than a less risky one. This is an essential input into valuation, reflected by the discount rate (i.e. how much a future cash flow is valued in today's money).
7) Investing doesn't need to be a DIY process. But if you're hiring someone, do it right. Any adviser worth his or her salt should demonstrate a keen appreciation of the factors I've listed above. I've written several posts on the characteristics of good investors (see here, here and here, for starters). Also, meet several advisers to get a sense of pricing. It may be worth it to pony up for a skilled adviser or fund manager, but don't forget that small differences in expenses and fees add up to big bucks over the long term through the power of compounding.
8) Ask advisers how they invest personally. Any fund manager should have a sizable portion of his net worth in his own fund. A financial adviser should similarly broadly follow the tenets he espouses for his clients. If a financial adviser has a markedly different asset allocation than the one he's proposed for you, then you should be asking some hard questions.
9) Challenge your adviser, but don't make unrealistic demands. Randomness means that short-term performance says little about an adviser's skill. Furthermore, there are times when it is entirely appropriate for your adviser to underperform a benchmark. For example, if financial markets are entering uncomfortably overvalued territory (based on logical, rational metrics, rather than just story-telling), a courageous and ethical fund manager or adviser may well underperform. Conversely, if an adviser or fund manager is suggesting things that you simply don't understand, it's ok to walk away. Perhaps you won't maximize your returns, but you'll hopefully avoid catastrophes and outright fraud.
10) "Gain all you can, save all you can, give all you can." John D. Rockefeller was reportedly a fan of this dictum, typically attributed to John Wesley. While reasonable people can disagree about what constitutes "all you can", the pithy saying holds some hard truths. The process of saving and investing isn't rocket science, but it requires discipline and a willingness to ignore the social pressure of over-spending. A healthy attitude to money is cultivated through conversations with financial professionals, but even more importantly by developing a sensible world-view that recognizes the limits of material well-being. There's no doubt that we have long-term savings goals such as kids' college tuition and health care in old age to save for. But many of us will be fortunate enough to contribute to worthy causes such as fighting childhood malnutrition and disease, or building educational and health institutions in impoverished countries. In a classic case of obliquity, we are likely to be better investors by not focusing excessively on our material well-being, and accepting the uncertainty that investing brings.
I wish you all a healthy, happy 2015 (even if that's too short a period to accurately assess your well-being, not to mention investment performance).
Saturday, December 6, 2014
There's Always Something To Do (On Peter Cundill)
The title of this post comes from a book of the same name on the Canadian value investor Peter Cundill. Frustrated by the lack of opportunities in a rich market, Cundill complained to his friend and mentor, Irving Kahn, who responded, "There is always something to do. You just need to look harder, be creative and a little flexible." This advice seems to have worked wonders for Cundill. His investment vehicle, the Cundill Value Funds, returned 15.2% per annum compounded over 33 years.
I enjoyed learning about Cundill's career and life, though I suspect this may be a bit of a niche read. Reading about a value investor is obviously not everyone's idea of a fun weekend, even though this is a very easy and entertaining little volume. Serious investors may complain that there isn't enough meat or technical detail to keep them engaged. I concede that the book doesn't really delve into the weeds of specific investments, but there are enough stories of investment successes - and even the occasional failure - to keep the reader captivated. The book is based on the personal diaries Cundill kept for over 30 years, and this intimate glimpse into his thinking really separates this book from most descriptions of famous investors. One entry admits, "I am tense because of the lack of performance, insecure and off form, which tends to make me aggressive and adopt a tone that jars." Rather than just reading a paean to a departed genius (Cundill died in 2011), we get to see the challenges of portfolio management, both as a craft and as a business.
Like the best investors and asset allocators, Cundill was fixated with parsing the personal characteristics that laid the foundation for investment success. His list included (1) Insatiable curiosity; (2) Patience; (3) Concentration; (4) Attention to detail; (5) Calculated risk-taking; (6) Independence of mind; (7) Humility; (8) Routines; (9) Physical activity; (10) Skepticism, and (11) Personal responsibility.
I'm surprised that the author didn't include "Flexibility" as one of the characteristics (though perhaps it's subsumed under "Curiosity"). The book's title is, after all, a tribute to the creativity and flexibility investors must sometimes show. An epigram Cundill enjoyed was, "Always change a winning game". Cundill was rigorous in demanding a margin of safety in his investments, usually backed by tangible assets, yet flexible in the application of this philosophy. While primarily an equities investor, he invested in distressed debt as well, including sovereign debt. Cundill was also willing to short markets (most successfully in Japan), though not individual securities. He was also geographically flexible, travelling widely to educate himself on different markets where value had become apparent.
One trait that is certainly mentioned is patience. "The most important attribute for success in value investing", Cundill declares, "is patience, patience, and more patience. The majority of investors do not possess this characteristic." I spent some time in a recent post emphasizing the important of serenity to investors, so this was naturally music to my ears. Patience takes various forms:
1) Doing the homework. "Very few people really do their homework properly, so now I always check for myself."
2) Patience in entering a trade. To use the language of my earlier post, insight is understanding the nature of cycles. Cundill quotes Horace, via Ben Graham: "Many shall be restored that now are fallen, and many shall fall that are now held in honour." Similarly, as Oscar Wilde says, "Saints always have a past and sinner always have a future." Yet insight must be allied with serenity, i.e. the patience to act. Cundill advises, "The trick is to wait through the crisis stage and into the boredom stage. Things will have settled down by then and values will be very cheap again." At the portfolio level, this may often necessitate large cash holdings. This is painful when markets are moving up, but also helps to reduce the likely volatility of the portfolio. I've written about the importance of cash in an earlier post.
3) Patience in evaluating new information, particularly in an era of instantaneous information transfer: "Computers actually don't do much more than make it quicker for investors to react to information. The problem is that having the information in its raw state on a second by second basis is not at all the same thing as interpreting and understanding its implications... Spur of the moment reactions to partially digested information are, more often than not, disastrous."
4) Patience in selling once you're starting to see the price move up. The temptation is to sell quickly, being so relieved that the trade has finally panned out.
The focus on "Routines" can probably be thought of more broadly as "Good Investing Habits". The most obvious of these Cundill practiced was keeping a journal, which allowed him to both reflect upon and document his thoughts. The writer Joan Didion believed that the benefit of keeping a journal is not to document objective reality but to remember how events felt to the individual. It goes without saying that I'm a big supporter of this idea, which drives me to maintain this blog. Another good investing habit was Cundill's practice of visiting the country that had the worst performing stock market in the previous eleven months. This forced him to seek investments outside North America, and extended his natural curiosity. Finally, as a serious marathon runner, Cundill believed that athletic stamina and mental resilience go hand in hand. This runs parallel (no pun intended) to an idea that has piqued my interest, namely Alex Soojung-Kim Pang's concept of "deliberate rest".
Developing these characteristics is hard,but obviously not impossible. Some may be tempted to conclude that nurturing these personal traits, along with the difficulty of understanding financial statements and business models, makes value investing too hard for most people. This is precisely the wrong conclusion. While it is "easy" to follow fatuous investment fads, it is devilishly difficult to make money that way. Cundill's example shows a well-trodden path that requires dedication, but is ultimately a boon to the investor's financial and psychological well-being.
At some points in the book, I found myself questioning if the Peter Cundill way could still be followed. First, many of his investment successes came from recognizing hidden assets in companies. These instances are harder to find today when corporates and activist investors are far more focused on "unlocking shareholder value". Furthermore, previously hidden assets, such as real estate, can now be revalued under IFRS to bring them into the light. The prevalence of such assets in the past made it easier to be a generalist if one could rely on them for value and obtain the underlying business for cheap (or sometimes even for free). Today's investors are generally more likely to have to spend more time on the decidedly less sturdy ground of assessing the durability of economic moats.
All the same, such criticisms do a disservice to the Peter Cundill way. After all, Cundill prided himself on adapting to different markets and investing regimes, rather than repeating the same trick over and over. As he and Irving Kahn would say, there's always something to do.
I enjoyed learning about Cundill's career and life, though I suspect this may be a bit of a niche read. Reading about a value investor is obviously not everyone's idea of a fun weekend, even though this is a very easy and entertaining little volume. Serious investors may complain that there isn't enough meat or technical detail to keep them engaged. I concede that the book doesn't really delve into the weeds of specific investments, but there are enough stories of investment successes - and even the occasional failure - to keep the reader captivated. The book is based on the personal diaries Cundill kept for over 30 years, and this intimate glimpse into his thinking really separates this book from most descriptions of famous investors. One entry admits, "I am tense because of the lack of performance, insecure and off form, which tends to make me aggressive and adopt a tone that jars." Rather than just reading a paean to a departed genius (Cundill died in 2011), we get to see the challenges of portfolio management, both as a craft and as a business.
Like the best investors and asset allocators, Cundill was fixated with parsing the personal characteristics that laid the foundation for investment success. His list included (1) Insatiable curiosity; (2) Patience; (3) Concentration; (4) Attention to detail; (5) Calculated risk-taking; (6) Independence of mind; (7) Humility; (8) Routines; (9) Physical activity; (10) Skepticism, and (11) Personal responsibility.
I'm surprised that the author didn't include "Flexibility" as one of the characteristics (though perhaps it's subsumed under "Curiosity"). The book's title is, after all, a tribute to the creativity and flexibility investors must sometimes show. An epigram Cundill enjoyed was, "Always change a winning game". Cundill was rigorous in demanding a margin of safety in his investments, usually backed by tangible assets, yet flexible in the application of this philosophy. While primarily an equities investor, he invested in distressed debt as well, including sovereign debt. Cundill was also willing to short markets (most successfully in Japan), though not individual securities. He was also geographically flexible, travelling widely to educate himself on different markets where value had become apparent.
One trait that is certainly mentioned is patience. "The most important attribute for success in value investing", Cundill declares, "is patience, patience, and more patience. The majority of investors do not possess this characteristic." I spent some time in a recent post emphasizing the important of serenity to investors, so this was naturally music to my ears. Patience takes various forms:
1) Doing the homework. "Very few people really do their homework properly, so now I always check for myself."
2) Patience in entering a trade. To use the language of my earlier post, insight is understanding the nature of cycles. Cundill quotes Horace, via Ben Graham: "Many shall be restored that now are fallen, and many shall fall that are now held in honour." Similarly, as Oscar Wilde says, "Saints always have a past and sinner always have a future." Yet insight must be allied with serenity, i.e. the patience to act. Cundill advises, "The trick is to wait through the crisis stage and into the boredom stage. Things will have settled down by then and values will be very cheap again." At the portfolio level, this may often necessitate large cash holdings. This is painful when markets are moving up, but also helps to reduce the likely volatility of the portfolio. I've written about the importance of cash in an earlier post.
3) Patience in evaluating new information, particularly in an era of instantaneous information transfer: "Computers actually don't do much more than make it quicker for investors to react to information. The problem is that having the information in its raw state on a second by second basis is not at all the same thing as interpreting and understanding its implications... Spur of the moment reactions to partially digested information are, more often than not, disastrous."
4) Patience in selling once you're starting to see the price move up. The temptation is to sell quickly, being so relieved that the trade has finally panned out.
The focus on "Routines" can probably be thought of more broadly as "Good Investing Habits". The most obvious of these Cundill practiced was keeping a journal, which allowed him to both reflect upon and document his thoughts. The writer Joan Didion believed that the benefit of keeping a journal is not to document objective reality but to remember how events felt to the individual. It goes without saying that I'm a big supporter of this idea, which drives me to maintain this blog. Another good investing habit was Cundill's practice of visiting the country that had the worst performing stock market in the previous eleven months. This forced him to seek investments outside North America, and extended his natural curiosity. Finally, as a serious marathon runner, Cundill believed that athletic stamina and mental resilience go hand in hand. This runs parallel (no pun intended) to an idea that has piqued my interest, namely Alex Soojung-Kim Pang's concept of "deliberate rest".
Developing these characteristics is hard,but obviously not impossible. Some may be tempted to conclude that nurturing these personal traits, along with the difficulty of understanding financial statements and business models, makes value investing too hard for most people. This is precisely the wrong conclusion. While it is "easy" to follow fatuous investment fads, it is devilishly difficult to make money that way. Cundill's example shows a well-trodden path that requires dedication, but is ultimately a boon to the investor's financial and psychological well-being.
At some points in the book, I found myself questioning if the Peter Cundill way could still be followed. First, many of his investment successes came from recognizing hidden assets in companies. These instances are harder to find today when corporates and activist investors are far more focused on "unlocking shareholder value". Furthermore, previously hidden assets, such as real estate, can now be revalued under IFRS to bring them into the light. The prevalence of such assets in the past made it easier to be a generalist if one could rely on them for value and obtain the underlying business for cheap (or sometimes even for free). Today's investors are generally more likely to have to spend more time on the decidedly less sturdy ground of assessing the durability of economic moats.
All the same, such criticisms do a disservice to the Peter Cundill way. After all, Cundill prided himself on adapting to different markets and investing regimes, rather than repeating the same trick over and over. As he and Irving Kahn would say, there's always something to do.
Monday, November 24, 2014
The Celtic Tiger Falls Into A Trap
The 2006-2011 Irish economic and financial crisis must certainly go down as one of the most dramatic collapses of recent years, despite a litany of strong contenders. Few other crises have highlighted so painfully just how quickly specific problems can morph into Hydra-like catastrophes. In the Irish case, a real estate crisis turned into a banking and financial system crisis, which turned into a fiscal crisis, leading to a sovereign debt crisis and contributing to a regional currency crisis.
I recently finished "The Fall of the Celtic Tiger" by Donovan and Murphy (henceforth D&M). I found it very enjoyable and informative on the specifics of the Irish crisis. The book does an excellent job of laying out the series of events that led to the Irish state guaranteeing the liabilities of its banking system in 2008 and the request for a Troika bailout in 2010. It also comprehensively highlights the role played by different actors in this tragedy, ranging from the property developers and banks to Irish politicians, regulators, media and the public. Few escape the book's critical but balanced gaze.
Somewhat unfairly, I'm going to focus on the book's few weaknesses. There is one actor that gets off too lightly in the book's treatment, in my view. That entity is (no surprises) the ECB. D&M describe ECB banking and credit policy, as well as its role as financial regulator and crisis manager. The narrative, however, gives insufficient due to the ECB's monetary policy decisions - surely the institution's most important function.
We can break these decisions down into several phases. First, we turn to the pre-crisis period in which the gigantic property bubble was inflating. D&M agree that the ECB's monetary policy did not suit Ireland for much of the 2000s, leading to higher than average inflation, and a sharp loss in external competitiveness. However, they insist that "to "blame" the ECB's monetary policy for the Irish property bubble is to misunderstand entirely the concept of a currency union" since monetary policy should be run for the Eurozone as a whole, not any specific country or region. Furthermore, D&M argue that "it is noteworthy that most of the other Eurozone countries, particularly those in northern Europe, did not borrow on the unprecedented scale that Ireland did. Were their central banks and regulatory authorities more aware of the potential dangers involved and did they discourage it? Or was it a case of different cultural approaches?" D&M seem to settle on "the accentuation of the traditional fixation of the Irish psyche on property" as the key to Ireland's particular mania.
I agree wholeheartedly that ECB policy should be run for the zone as a whole (even if the reality is that decisions are asymmetric with respect to Germany). But D&M seem to take as a given that Ireland belongs in the Eurozone, despite noting that "this is the second time in twenty-five years that Ireland has faced major economic and financial difficulties. Bernard Connolly's excellent "The Rotten Heart of Europe" reveals the paucity of reason behind Ireland's decision to join the currency union. Rather than resorting to cultural reasons, D&M seem to have underplayed the fact that Irish nominal GDP was running far, far too high from 2001-07.
You can look at the Google Data visual depiction on your own if interested. I concede that Ireland's deviation from a healthy NGDP trend was not the ECB's "fault" per se, but rather the inappropriateness of a one-size-fits-all monetary policy, which D&M underplay.
We next turn to 2008. Few central banks covered themselves in glory in understanding the interaction between tight money and economic and financial collapse. The ECB, of course, was particularly culpable in raising rates in July 2008.
As a financial regulator, the ECB compounded this mistake. As D&M note, "while not prepared to embark on any specific rescue package for a country in difficulties, [the ECB] opposed strongly any suggestion of the country in question allowing its banking system to default." It is particularly curious that European authorities such as the ECB are very keen on protecting domestic banking structures despite moral hazard risk. Yet they spew jeremiads about that risk when dealing with sovereigns.
2008-2010 offered another phase of the Irish crisis, after the banking guarantee. D&M correctly note that "periodic upward revisions of the extent of the banking disaster contributing to an underlying erosion of market confidence". Yet the ECB seems to escape any criticism for this state of affairs. Its overly tight monetary policy did little to assuage the effects of a broad deterioration in European banking. What's worse, the correspondence between Finance Minister Brian Lenihan and ECB President Trichet shows the ECB's deep and unhealthy involvement in Irish political economy. It is laughable that some "sound money" types in the US have praised the ECB for its rigid adherence to (if unsuccessful achievement of) its inflation targeting mandate. The ECB, as I have underscored before, is an intensely political beast - far more so than the Federal Reserve.
Finally, we come to the post-2010 period. D&M rightly state that "the absence of any significant GDP growth has rendered the achievement of deficit/GDP and debt/GDP targets that much more difficult", but do not point to the ECB for its role. The infamous 2011 rate rises are the worst example of the ECB's performance, which has compounded Ireland's difficulties. Again, in highlighting the ECB's mistakes, I do not want to exonerate the other actors who D&M do such an excellent job of identifying. There would have been a collapse in Irish property prices even without the ECB's raft of mistakes. But these errors - and the general inadequacy of the Euro for its members - must surely be cited.
To end, I want to draw one major lesson from D&M's generally excellent treatment of this crisis, namely that understandable emotions are the enemy of good economic policy. First, the decision to join the European Monetary System in December 1978 led to the breaking of the one-to-one parity of the Irish pound with sterling in March 1979. The breaking of parity "was perceived as representing a symbol of success as a nation." Yet this desire to be free of the UK's influence led eventually to the property bubble by yoking Ireland to the ECB. And of course, this unfortunate manifestation of nationalism was equally apparent when the bailout occurred. In Nov 2010, the Irish Times asked whether the men of 1916 had died for "a bailout from the German Chancellor with a few shillings of sympathy from the British Chancellor on the side... the shame of it all." As D&M write, "The loss of sovereignty was palpable."
If national pride is a bad guide to economic policy, empathy is equally to blame. D&M write that "The roots of the Irish fiscal disaster were initiated by a political decision, implicitly shared by all political parties, that the fruits of the boom should not be confined to those involved directly in property." An understandable desire to share the bounty of good fortune (or perhaps the opportunism of politicians) led to disastrous fiscal decisions, weakening the government's finances right when they were needed the most.
All in all, D&M do a superb job of explaining the Irish economic and financial catastrophe. While there is a human tendency to want to blame individual actors or identify specific causes, D&M show cogently how the Celtic tiger fell into a trap that it is still struggling to escape.
I recently finished "The Fall of the Celtic Tiger" by Donovan and Murphy (henceforth D&M). I found it very enjoyable and informative on the specifics of the Irish crisis. The book does an excellent job of laying out the series of events that led to the Irish state guaranteeing the liabilities of its banking system in 2008 and the request for a Troika bailout in 2010. It also comprehensively highlights the role played by different actors in this tragedy, ranging from the property developers and banks to Irish politicians, regulators, media and the public. Few escape the book's critical but balanced gaze.
Somewhat unfairly, I'm going to focus on the book's few weaknesses. There is one actor that gets off too lightly in the book's treatment, in my view. That entity is (no surprises) the ECB. D&M describe ECB banking and credit policy, as well as its role as financial regulator and crisis manager. The narrative, however, gives insufficient due to the ECB's monetary policy decisions - surely the institution's most important function.
We can break these decisions down into several phases. First, we turn to the pre-crisis period in which the gigantic property bubble was inflating. D&M agree that the ECB's monetary policy did not suit Ireland for much of the 2000s, leading to higher than average inflation, and a sharp loss in external competitiveness. However, they insist that "to "blame" the ECB's monetary policy for the Irish property bubble is to misunderstand entirely the concept of a currency union" since monetary policy should be run for the Eurozone as a whole, not any specific country or region. Furthermore, D&M argue that "it is noteworthy that most of the other Eurozone countries, particularly those in northern Europe, did not borrow on the unprecedented scale that Ireland did. Were their central banks and regulatory authorities more aware of the potential dangers involved and did they discourage it? Or was it a case of different cultural approaches?" D&M seem to settle on "the accentuation of the traditional fixation of the Irish psyche on property" as the key to Ireland's particular mania.
I agree wholeheartedly that ECB policy should be run for the zone as a whole (even if the reality is that decisions are asymmetric with respect to Germany). But D&M seem to take as a given that Ireland belongs in the Eurozone, despite noting that "this is the second time in twenty-five years that Ireland has faced major economic and financial difficulties. Bernard Connolly's excellent "The Rotten Heart of Europe" reveals the paucity of reason behind Ireland's decision to join the currency union. Rather than resorting to cultural reasons, D&M seem to have underplayed the fact that Irish nominal GDP was running far, far too high from 2001-07.
You can look at the Google Data visual depiction on your own if interested. I concede that Ireland's deviation from a healthy NGDP trend was not the ECB's "fault" per se, but rather the inappropriateness of a one-size-fits-all monetary policy, which D&M underplay.
We next turn to 2008. Few central banks covered themselves in glory in understanding the interaction between tight money and economic and financial collapse. The ECB, of course, was particularly culpable in raising rates in July 2008.
As a financial regulator, the ECB compounded this mistake. As D&M note, "while not prepared to embark on any specific rescue package for a country in difficulties, [the ECB] opposed strongly any suggestion of the country in question allowing its banking system to default." It is particularly curious that European authorities such as the ECB are very keen on protecting domestic banking structures despite moral hazard risk. Yet they spew jeremiads about that risk when dealing with sovereigns.
2008-2010 offered another phase of the Irish crisis, after the banking guarantee. D&M correctly note that "periodic upward revisions of the extent of the banking disaster contributing to an underlying erosion of market confidence". Yet the ECB seems to escape any criticism for this state of affairs. Its overly tight monetary policy did little to assuage the effects of a broad deterioration in European banking. What's worse, the correspondence between Finance Minister Brian Lenihan and ECB President Trichet shows the ECB's deep and unhealthy involvement in Irish political economy. It is laughable that some "sound money" types in the US have praised the ECB for its rigid adherence to (if unsuccessful achievement of) its inflation targeting mandate. The ECB, as I have underscored before, is an intensely political beast - far more so than the Federal Reserve.
Finally, we come to the post-2010 period. D&M rightly state that "the absence of any significant GDP growth has rendered the achievement of deficit/GDP and debt/GDP targets that much more difficult", but do not point to the ECB for its role. The infamous 2011 rate rises are the worst example of the ECB's performance, which has compounded Ireland's difficulties. Again, in highlighting the ECB's mistakes, I do not want to exonerate the other actors who D&M do such an excellent job of identifying. There would have been a collapse in Irish property prices even without the ECB's raft of mistakes. But these errors - and the general inadequacy of the Euro for its members - must surely be cited.
To end, I want to draw one major lesson from D&M's generally excellent treatment of this crisis, namely that understandable emotions are the enemy of good economic policy. First, the decision to join the European Monetary System in December 1978 led to the breaking of the one-to-one parity of the Irish pound with sterling in March 1979. The breaking of parity "was perceived as representing a symbol of success as a nation." Yet this desire to be free of the UK's influence led eventually to the property bubble by yoking Ireland to the ECB. And of course, this unfortunate manifestation of nationalism was equally apparent when the bailout occurred. In Nov 2010, the Irish Times asked whether the men of 1916 had died for "a bailout from the German Chancellor with a few shillings of sympathy from the British Chancellor on the side... the shame of it all." As D&M write, "The loss of sovereignty was palpable."
If national pride is a bad guide to economic policy, empathy is equally to blame. D&M write that "The roots of the Irish fiscal disaster were initiated by a political decision, implicitly shared by all political parties, that the fruits of the boom should not be confined to those involved directly in property." An understandable desire to share the bounty of good fortune (or perhaps the opportunism of politicians) led to disastrous fiscal decisions, weakening the government's finances right when they were needed the most.
All in all, D&M do a superb job of explaining the Irish economic and financial catastrophe. While there is a human tendency to want to blame individual actors or identify specific causes, D&M show cogently how the Celtic tiger fell into a trap that it is still struggling to escape.
Monday, November 17, 2014
Serenity, Insight and Investing
I've been reading Bhikku Bodhi's "In the Buddha's Words", which is an anthology of discourses from the collection of Buddhist scriptures known as the Pali Canon. The message is simple but powerful: "From development of the mind arise happiness, freedom, and peace." He goes on, "Development of the mind... means the development of serenity (samatha) and insight (vipassana). Both serenity and insight are considered necessary to achieve true development. "The cultivation of serenity requires skill in steadying, composing, unifying, and concentrating the mind. The cultivation of insight requires skill in observing, investigating, and discerning conditioned phenomena...While meditators may [approach the two aspects] differently, eventually they must all strike a healthy balance between serenity and insight."
While these precepts form the foundation of one of the world's major philosophical traditions, one does not need to be a Buddhist to see their broad applicability. Stoic philosophy conveys similar ideas. Closer to the current day, Jonathan Haidt's "The Happiness Hypothesis" presents another metaphor, that of the elephant and the rider. The mind is divided between conscious/reasoned processes and automatic/implicit processes. These two parts are like a rider atop an elephant. The rider's inability to control the elephant explains many puzzles about our mental lives. Haidt posits that learning how to train the elephant is key to self-improvement.
Unsurprisingly, I think these ideas provide a useful philosophical basis for the tiny sliver of life that is investing. I've written before about Robert Hagstrom's view of investing as the last liberal art. Investors need a grasp of (in order of least controversial to most controversial) finance, microeconomics, macroeconomics, psychology, history and sociology. All these contribute to insight, i.e. seeing the financial markets as they really are, and being humble enough to create a risk management framework that deals with the uncertainty inherent in investing. Developing insight is certainly more than just being knowledgeable, particularly in this era of Information. It's about trying to develop wisdom. To quote T.S. Eliot, "Where is the wisdom we have lost in knowledge? Where is the knowledge we have lost in information?" It's easy to mistake information for knowledge, and knowledge for wisdom.
That said, even wisdom seems to only be part of the equation. One can be a brilliant analyst but lack the equanimity and humility required to translate good ideas into successful investments.Serenity allows the investor to actually implement an investment, and to maintain an even keel whether things are going particularly well or particularly badly. Anyone observing financial markets comes to realize that they just another medium conveying the vicissitudes of human life. Fear and greed are rightly identified as two emotions that drive much of how we act in financial markets. But market participants experience other emotions too: for example, they experience anger, disgust and shame when taking losses, trust and pride when things appear to be going well, and confusion when market action goes against expectations. The skilled investor therefore needs to be master of his own emotions. Despite his homespun image, Warren Buffett too merges investing acumen with a steely constitution, and the combination has led to his stellar record. Stan Druckenmiller is more of a trader than a value-oriented investor, but my former boss Scott Bessent, in "Inside the House of Money", describes Druckenmiller's toolkit as such: "Stan may be the greatest moneymaking machine in history. He has Jim Rogers' analytical ability, George Soros's trading ability, and the stomach of a riverboat gambler when it comes to placing bets."
The emotional component to investing is well-recognized these days, with books like Kahneman's "Thinking Fast and Slow" popularizing behavioural economics. Kahneman uses the terms System 1 and System 2 to represent fast, unconscious thoughts and slow, effortful thoughts respectively - analogous to Haidt's elephant and rider respectively. But despite Kahneman's literary success, my guess is that investors still pay far less attention to this side of investing than they should. While there are numerous mainstream avenues to develop the analytical tools of investing (again, just one part of insight, in my analogy), such as going to business school or getting the CFA qualification, these tools are not worth very much without a sound emotional grounding. In fact, they can even be harmful, creating the illusion of certainty where none exists.
Sadly, there aren't schools devoted to helping investors gain the type of serenity they need. Most investors (retail and professional) succumb to those old enemies, fear and greed, far too often, leading to sub-optimal investment performance. Perhaps we all need to take a step back to learn from Druckenmiller and Buffett - and maybe even the Buddha.
While these precepts form the foundation of one of the world's major philosophical traditions, one does not need to be a Buddhist to see their broad applicability. Stoic philosophy conveys similar ideas. Closer to the current day, Jonathan Haidt's "The Happiness Hypothesis" presents another metaphor, that of the elephant and the rider. The mind is divided between conscious/reasoned processes and automatic/implicit processes. These two parts are like a rider atop an elephant. The rider's inability to control the elephant explains many puzzles about our mental lives. Haidt posits that learning how to train the elephant is key to self-improvement.
Unsurprisingly, I think these ideas provide a useful philosophical basis for the tiny sliver of life that is investing. I've written before about Robert Hagstrom's view of investing as the last liberal art. Investors need a grasp of (in order of least controversial to most controversial) finance, microeconomics, macroeconomics, psychology, history and sociology. All these contribute to insight, i.e. seeing the financial markets as they really are, and being humble enough to create a risk management framework that deals with the uncertainty inherent in investing. Developing insight is certainly more than just being knowledgeable, particularly in this era of Information. It's about trying to develop wisdom. To quote T.S. Eliot, "Where is the wisdom we have lost in knowledge? Where is the knowledge we have lost in information?" It's easy to mistake information for knowledge, and knowledge for wisdom.
That said, even wisdom seems to only be part of the equation. One can be a brilliant analyst but lack the equanimity and humility required to translate good ideas into successful investments.Serenity allows the investor to actually implement an investment, and to maintain an even keel whether things are going particularly well or particularly badly. Anyone observing financial markets comes to realize that they just another medium conveying the vicissitudes of human life. Fear and greed are rightly identified as two emotions that drive much of how we act in financial markets. But market participants experience other emotions too: for example, they experience anger, disgust and shame when taking losses, trust and pride when things appear to be going well, and confusion when market action goes against expectations. The skilled investor therefore needs to be master of his own emotions. Despite his homespun image, Warren Buffett too merges investing acumen with a steely constitution, and the combination has led to his stellar record. Stan Druckenmiller is more of a trader than a value-oriented investor, but my former boss Scott Bessent, in "Inside the House of Money", describes Druckenmiller's toolkit as such: "Stan may be the greatest moneymaking machine in history. He has Jim Rogers' analytical ability, George Soros's trading ability, and the stomach of a riverboat gambler when it comes to placing bets."
The emotional component to investing is well-recognized these days, with books like Kahneman's "Thinking Fast and Slow" popularizing behavioural economics. Kahneman uses the terms System 1 and System 2 to represent fast, unconscious thoughts and slow, effortful thoughts respectively - analogous to Haidt's elephant and rider respectively. But despite Kahneman's literary success, my guess is that investors still pay far less attention to this side of investing than they should. While there are numerous mainstream avenues to develop the analytical tools of investing (again, just one part of insight, in my analogy), such as going to business school or getting the CFA qualification, these tools are not worth very much without a sound emotional grounding. In fact, they can even be harmful, creating the illusion of certainty where none exists.
Sadly, there aren't schools devoted to helping investors gain the type of serenity they need. Most investors (retail and professional) succumb to those old enemies, fear and greed, far too often, leading to sub-optimal investment performance. Perhaps we all need to take a step back to learn from Druckenmiller and Buffett - and maybe even the Buddha.
Wednesday, October 22, 2014
Are You A Value Investor, Or Just A Cheapskate?
There's a big difference between being a value investor and merely being a cheapskate. The dictum goes, "Price is what you pay; value's what you get." To the skilled investor, value reflects the exploitable wedge between price and value. It's a relative concept, rather than an absolute level. This is often hard to remember because we use the same words - "cheap" and "expensive" - to describe two concepts. Something can be cheap relative to its inherent qualities, or cheap in an absolute sense, which is to say selling at a low dollar price. It's often helpful to clarify which people mean.
The father of value investing, Ben Graham, was occasionally unclear on this point. His most famous disciple, Warren Buffett, notably adapted his investing style to incorporate quality as a component of value (influenced by Charlie Munger). In fact, Graham almost made a gigantic error by being a cheapskate rather than a value investor. Buffett recounts, "I offered to go to work at Graham-Newman for nothing after I took Ben Graham's class but he turned me down as overvalued. He took this value stuff very seriously!" Buffett might just be being kind here - if I recall correctly, I've read elsewhere that Graham turned Buffett down because young Jewish men were being barred from so many places on Wall Street that he felt inclined to save spots for them to work at Graham-Newman. But at any rate, the thought of Graham turning away the bright young Buffett seems like an act of folly.
The distinction between value investing and being a cheapskate applies to regular life too. I posted about a month ago about this paper by Bronnenberg, Dube, Gentzkow and Shapiro that found that informed consumers of headache remedies (such as pharmacists) were less likely to pay extra for national brands, preferring store brands and generics. BDGS suggest therefore that "misinformation explains a sizeable share of the brand premium for health products." In other words, those who are better informed can see past marketing and therefore opt for a lower priced product with the same efficacy.
About a week after writing that post, I found myself choosing between a brand name health product costing $90 and a generic brand at $60. "Screw you, brand name," I proudly thought. "I've read my BDGS." Big mistake. Three weeks later, I discovered the product wasn't working, and was forced to cough up for the more expensive alternative.
Really, I made two mistakes. First, I incorrectly extrapolated the BDGS finding from the relatively narrow world of headache remedies to a completely separate product. Second, the BDGS finding referred to informed consumers. Alas, that's not me. I'm just a guy who heard a podcast and read a paper. I believed I'd found an exploitable wedge between price and value - and I was wrong.
Thankfully the mistake was minor, and reversible (well, I hope so!). Investing forces us to be both arrogant and humble at the same time, believing that the multitude of investors we call the market is wrong, but being conscious that we might be wrong. The world is full of value traps - investments that look "cheap" but are not. Equally, there are opportunities that appear expensive, when in fact the odds of success and future cash flows are sufficiently favourable as so offset a purportedly high price. I credit Charlie Munger and certainly Phil Fisher for clarifying my thinking on this point. Similarly, value investors sometimes take pride in being thrifty or being out-and-out cheapskates in their daily lives. That, I believe, is a big mistake. Knowing the difference between price and value is a crucial component of value investing - and indeed life.
The father of value investing, Ben Graham, was occasionally unclear on this point. His most famous disciple, Warren Buffett, notably adapted his investing style to incorporate quality as a component of value (influenced by Charlie Munger). In fact, Graham almost made a gigantic error by being a cheapskate rather than a value investor. Buffett recounts, "I offered to go to work at Graham-Newman for nothing after I took Ben Graham's class but he turned me down as overvalued. He took this value stuff very seriously!" Buffett might just be being kind here - if I recall correctly, I've read elsewhere that Graham turned Buffett down because young Jewish men were being barred from so many places on Wall Street that he felt inclined to save spots for them to work at Graham-Newman. But at any rate, the thought of Graham turning away the bright young Buffett seems like an act of folly.
The distinction between value investing and being a cheapskate applies to regular life too. I posted about a month ago about this paper by Bronnenberg, Dube, Gentzkow and Shapiro that found that informed consumers of headache remedies (such as pharmacists) were less likely to pay extra for national brands, preferring store brands and generics. BDGS suggest therefore that "misinformation explains a sizeable share of the brand premium for health products." In other words, those who are better informed can see past marketing and therefore opt for a lower priced product with the same efficacy.
About a week after writing that post, I found myself choosing between a brand name health product costing $90 and a generic brand at $60. "Screw you, brand name," I proudly thought. "I've read my BDGS." Big mistake. Three weeks later, I discovered the product wasn't working, and was forced to cough up for the more expensive alternative.
Really, I made two mistakes. First, I incorrectly extrapolated the BDGS finding from the relatively narrow world of headache remedies to a completely separate product. Second, the BDGS finding referred to informed consumers. Alas, that's not me. I'm just a guy who heard a podcast and read a paper. I believed I'd found an exploitable wedge between price and value - and I was wrong.
Thankfully the mistake was minor, and reversible (well, I hope so!). Investing forces us to be both arrogant and humble at the same time, believing that the multitude of investors we call the market is wrong, but being conscious that we might be wrong. The world is full of value traps - investments that look "cheap" but are not. Equally, there are opportunities that appear expensive, when in fact the odds of success and future cash flows are sufficiently favourable as so offset a purportedly high price. I credit Charlie Munger and certainly Phil Fisher for clarifying my thinking on this point. Similarly, value investors sometimes take pride in being thrifty or being out-and-out cheapskates in their daily lives. That, I believe, is a big mistake. Knowing the difference between price and value is a crucial component of value investing - and indeed life.
Saturday, October 11, 2014
It's Not Time To Worry Yet; They Won't Do It Again
In Nov 2002, Ben Bernanke, then a member of the Fed Board of Governors, gave a speech to honour Milton Friedman's 90th birthday. In the speech, Bernanke summarized the findings of Friedman and Schwartz's work on the Great Depression, concluding that "Monetary forces, particularly if unleashed in a destabilizing direction, can be extremely powerful. The best thing that central bankers can do for the world is to avoid such crises by providing the economy with, in Milton Friedman's words, "a stable monetary background" - for example as reflected in low and stable inflation." He famously ended, "I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."
Less than 2 weeks later, Bernanke gave another important speech at the National Economists Club, entitled "Deflation: Making Sure "It" Doesn't Happen Here". While the first speech covered historical episodes of monetary-induced volatility, the second focused on future policy prescriptions to combat deflation, countering in particular the notion that monetary policy was impotent at the zero lower bound (ZLB).
(Aside no.1: It's interesting that these two speeches, arguably the best-known of Bernanke's speeches, were given within 2 weeks of each other. As a Fed Governor, Bernanke was in the sweet spot of being able to be relatively candid while having access to the highest corridors of power. Most of his later speeches are necessarily more cautious, and are understandably less objective since they, to some extent, have to defend decisions that he and his colleagues took.)
(Aside no. 2: Wikipedia tells me that Bernanke is married to Anna Friedmann, confirmed by the NYT. I guess Friedman & Schwartz's work had an even bigger impact on Bernanke than he knows. Milton Schwartz was his next option.)
If you've never read the speeches, or if it's been awhile since you last read them, I encourage you to spend 30 minutes (I'm a slow reader) and marvel at their lucidity and prescience. Reading them isn't merely an academic exercise. For investors, the first would have warned you of the potential impacts of the ill-fated decisions in 2008 to focus on inflation. The second laid out the Bernanke playbook, and could have helped you understand the possible rebound in economic performance and asset prices. It's easy to say that in retrospect, of course. But I find it interesting to go back to these speeches as we wrestle with another question: Will we see another 2008?
The answer to this question depends a great deal on one's reading of the causes of the 2007-2009 conflagration, and deciding if similar conditions are in place. You don't have to look far to find those worrying about the fragility of the financial markets. Noted bear John Hussman wrote recently, "I view the stock market as likely to lose more than half of its value from its recent highs to its ultimate low in this market cycle." A host of savvy investors, most pertinently Seth Klarman, have expressed their concerns about market valuations and sentiment. There are also those like the excellent SoberLook.com who look at this chart of investor sentiment (from Yardeni Research) and conclude that there isn't enough bearishness in the market:
And of course, the Fed has voiced its concerns about valuations in tech stocks and the leveraged loan market recently.
I haven't exactly been a bundle of optimism this year, worrying that the Fed is extremely unlikely to allow (or generate) a boom that would make up for some of the lost growth of the past 7 years. And I agree there are many reasons to be bearish - the Fed concluding its asset purchase programme, the seemingly intractable problems in the Eurozone, slow relative growth in the Chinese economy, and a plethora of geopolitical conflicts.
But still, I have to say, I just don't think conditions are the same for another meltdown. My quick summary of 2007-2009 is as follows: a serious financial crisis occurred due to lax credit conditions, poorly understood financial instruments, and inaccurate beliefs about risk. This interacted in powerful and catastrophic ways with serious monetary policy errors to produce an economic and financial spiral.Specifically, there was an inappropriate focus on inflation at the expense of growth, compounded by paralysis when confronted with the ZLB.
The situation today seems a little different:
(1) Sentiment does not seem as optimistic. There may be fewer bears, but there are fewer bulls as well. I don't think it's realistic to say that we've gone back to the go-go days of the Dotcom bubble or 2007. Investor psychology was profoundly altered by the experience of the dark days of 2008 in particular. Yes, 7 years later, the memories have faded a bit, but I simply don't buy the argument that investors are ready to throw caution to the wind. Are there sectors that are overvalued? Almost certainly. But that's how markets work.
(2) The policy landscape is completely different. The psychological barrier of breaking $100 oil has long been shattered, reducing the risk of inflation-phobia. Far more importantly, the playbook of tools for easing at the ZLB has been firmly established. In his speech on deflation, Bernanke pointed out that "an essential element [of taming the inflation dragon] was the heightened understanding by central bankers and, equally as important, by political leaders and the public at large of the very high costs of allowing the economy to stray too far from price stability."A similar story applies to easing at the ZLB. There was a story in the news today about the Bank of Israel (which has been extremely innovative in the past few years) being willing to consider unconventional tools should rate cuts fail to achieve the inflation target. Stories like this no longer even make us bat an eyelid. Yes, the ECB is struggling to implement QE, but that's for political reasons. I accept, and worry, that there are short-term risks that the Fed would be relatively slow to reverse its tightening course even if serious global shocks occurred. But another 2008 simply doesn't seem to be in the offing.
One of my favourite quotes (from one of my favourite books) is Atticus Finch's refrain "It's not time to worry yet" in "To Kill A Mockingbird". I suppose that Finch-ism captures how I feel about the state of the equity markets in particular. Successful long-term investing requires discipline - discipline to ride out periods of volatility, and discipline to take advantage of ebbs and flows in investor psychology. That's the best way I know to harvest risk premia over the long run.Of course there are times to worry, particularly when no-one else seems to be doing so. But for the time being, I'm taking the Fed at its word that, thanks to Milton and Anna, they won't do "it" again.
Less than 2 weeks later, Bernanke gave another important speech at the National Economists Club, entitled "Deflation: Making Sure "It" Doesn't Happen Here". While the first speech covered historical episodes of monetary-induced volatility, the second focused on future policy prescriptions to combat deflation, countering in particular the notion that monetary policy was impotent at the zero lower bound (ZLB).
(Aside no.1: It's interesting that these two speeches, arguably the best-known of Bernanke's speeches, were given within 2 weeks of each other. As a Fed Governor, Bernanke was in the sweet spot of being able to be relatively candid while having access to the highest corridors of power. Most of his later speeches are necessarily more cautious, and are understandably less objective since they, to some extent, have to defend decisions that he and his colleagues took.)
(Aside no. 2: Wikipedia tells me that Bernanke is married to Anna Friedmann, confirmed by the NYT. I guess Friedman & Schwartz's work had an even bigger impact on Bernanke than he knows. Milton Schwartz was his next option.)
If you've never read the speeches, or if it's been awhile since you last read them, I encourage you to spend 30 minutes (I'm a slow reader) and marvel at their lucidity and prescience. Reading them isn't merely an academic exercise. For investors, the first would have warned you of the potential impacts of the ill-fated decisions in 2008 to focus on inflation. The second laid out the Bernanke playbook, and could have helped you understand the possible rebound in economic performance and asset prices. It's easy to say that in retrospect, of course. But I find it interesting to go back to these speeches as we wrestle with another question: Will we see another 2008?
The answer to this question depends a great deal on one's reading of the causes of the 2007-2009 conflagration, and deciding if similar conditions are in place. You don't have to look far to find those worrying about the fragility of the financial markets. Noted bear John Hussman wrote recently, "I view the stock market as likely to lose more than half of its value from its recent highs to its ultimate low in this market cycle." A host of savvy investors, most pertinently Seth Klarman, have expressed their concerns about market valuations and sentiment. There are also those like the excellent SoberLook.com who look at this chart of investor sentiment (from Yardeni Research) and conclude that there isn't enough bearishness in the market:
And of course, the Fed has voiced its concerns about valuations in tech stocks and the leveraged loan market recently.
I haven't exactly been a bundle of optimism this year, worrying that the Fed is extremely unlikely to allow (or generate) a boom that would make up for some of the lost growth of the past 7 years. And I agree there are many reasons to be bearish - the Fed concluding its asset purchase programme, the seemingly intractable problems in the Eurozone, slow relative growth in the Chinese economy, and a plethora of geopolitical conflicts.
But still, I have to say, I just don't think conditions are the same for another meltdown. My quick summary of 2007-2009 is as follows: a serious financial crisis occurred due to lax credit conditions, poorly understood financial instruments, and inaccurate beliefs about risk. This interacted in powerful and catastrophic ways with serious monetary policy errors to produce an economic and financial spiral.Specifically, there was an inappropriate focus on inflation at the expense of growth, compounded by paralysis when confronted with the ZLB.
The situation today seems a little different:
(1) Sentiment does not seem as optimistic. There may be fewer bears, but there are fewer bulls as well. I don't think it's realistic to say that we've gone back to the go-go days of the Dotcom bubble or 2007. Investor psychology was profoundly altered by the experience of the dark days of 2008 in particular. Yes, 7 years later, the memories have faded a bit, but I simply don't buy the argument that investors are ready to throw caution to the wind. Are there sectors that are overvalued? Almost certainly. But that's how markets work.
(2) The policy landscape is completely different. The psychological barrier of breaking $100 oil has long been shattered, reducing the risk of inflation-phobia. Far more importantly, the playbook of tools for easing at the ZLB has been firmly established. In his speech on deflation, Bernanke pointed out that "an essential element [of taming the inflation dragon] was the heightened understanding by central bankers and, equally as important, by political leaders and the public at large of the very high costs of allowing the economy to stray too far from price stability."A similar story applies to easing at the ZLB. There was a story in the news today about the Bank of Israel (which has been extremely innovative in the past few years) being willing to consider unconventional tools should rate cuts fail to achieve the inflation target. Stories like this no longer even make us bat an eyelid. Yes, the ECB is struggling to implement QE, but that's for political reasons. I accept, and worry, that there are short-term risks that the Fed would be relatively slow to reverse its tightening course even if serious global shocks occurred. But another 2008 simply doesn't seem to be in the offing.
One of my favourite quotes (from one of my favourite books) is Atticus Finch's refrain "It's not time to worry yet" in "To Kill A Mockingbird". I suppose that Finch-ism captures how I feel about the state of the equity markets in particular. Successful long-term investing requires discipline - discipline to ride out periods of volatility, and discipline to take advantage of ebbs and flows in investor psychology. That's the best way I know to harvest risk premia over the long run.Of course there are times to worry, particularly when no-one else seems to be doing so. But for the time being, I'm taking the Fed at its word that, thanks to Milton and Anna, they won't do "it" again.
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