We Already Wrote This Commentary

By Nick Fisher, Portfolio Manager


The middle of 2015 might very well mark a temporary high in stock markets worldwide. Commodities and transports led the way down signaling a slowing of Chinese economic growth (a clear benefactor of low worldwide interest rates). Stock markets managed to survive almost 6 months from the time US Federal Reserve ceased their unprecedented monetary policy of quantitative easing. Without this blatant market manipulation, most asset classes peaked by the late spring and have been having difficulty gaining any upward momentum since.

As of this writing at the end of January 2016, the markets have been quite volatile. We have had a few conversations over the last couple years with clients wondering why we were so conservative. A few actually pointed to other investors who were earning a more substantial return, while their returns were more subdued. It is amazing how quickly the narrative in the market has changed from momentum-based risk taking to capital preservation.

To recap, from our past newsletters where we have come from:

As a result of the grand experiment of unprecedented monetary policy enacted by the US Federal Reserve, investors who were unwilling to accept the paltry returns available in safe haven assets began taking more risk. We demonstrated this by looking at the change in the capital markets line from a normal environment to the present environment.

Clearly valuations in many asset classes were becoming at the least, fully valued and at most extremely over valued. As we know, above average valuations are followed by periods of low return. This type of environment does not adequately compensate an investor for taking risks. We said that this behavior of reaching for return, while only regarding the recent volatility as a guidepost for risk, would “…end with mal-investment and the loss of capital for less disciplined investors.”

An unconventional portfolio, with a slightly higher emphasis on liquidity and a tolerance for greater volatility will be necessary to earn higher returns. Furthermore “…we are not forced to swing at every pitch and there are no called strikes, therefore it is prudent to “wait for our pitch.” A skew towards lower risk, safer assets will be necessary to avoid the siren song of short-termism.

While we are not very good at predicting when a correction will happen, we can be certain that it will. We must be prepared, as the lower prices will create plenty of opportunity. Our emphasis is not on how much less we have lost relative to the markets, rather the opportunities that we are looking at presently.


Let’s look at what some of the most intelligent people in finance have to say about the Federal Reserve’s QE, stock market valuations, demographics and inflation:

I believe we engineered a version of the "Wimpy philosophy": We gave stock-market investors two hamburgers today in exchange for one or none tomorrow. We pulled forward the price-reaction function of markets. If that is a correct assessment, then there may well be a payback period of lesser movement in stock prices to follow. 2015 might have been the beginning of that balancing out...It would not be unreasonable to expect subdued returns this year given that stocks are still richly priced by historic standards.

Now we will see who the truly smart investors are and who merely looked smart by having ridden the rising tide engineered by the Fed. As Warren Buffet has often said: "you only learn who has been swimming naked when the tide goes out."

– Richard Fisher, 2005-2015 President of Federal Reserve Bank of Dallas

Of course, I’m so old I remember coffee at five cents, and all-you-can-eat cafeterias at 25 cents, and brand new automobiles for $600. Over a span of many decades you can count on democracy to cause the money to deteriorate…Somebody my age has lived through the best and easiest period that ever happened in the history of the world…the biggest increases per annum that most people’s standard of living ever got…If you’re unhappy with what you’ve had over the last 50 years, you have an unfortunate misappraisal of life. It’s as good as it gets, and it’s very likely to get worse. It’s always wise to be prepared for it…It’s the unfavorable surprises that cause the trouble. You can almost count on the fact that you’ll have way more trouble in the next 50 years than we had in the last…We should all be prepared to adjust to a world that is harder.

- Charlie Munger, Vice Chairman of Berkshire Hathaway

Well it is true that if much of the developing world is younger demographically (think India), then developed nations could and should transfer an increasing percentage of their financial assets to emerging markets to help foot the demographic bills back home. It’s also commonsensical that if higher Millennial wages are the probable result of a shortage of healthcare workers relative to Boomer requirements, then an investor should go long inflation and short fixed coupons…Other (developed) countries have similar burdens. Boomers have in part been responsible for asset appreciation during the heyday of their productive years and that now, drip by drip, year by year, they will need to sell those assets to someone or some country in order to pay their own bills. Asset returns will therefore be lower than historical norms, especially because interest rates are close to 0% in developed countries.

- Bill Gross, “Bond King” Portfolio Manager for Janus Capital

The bottom line: if the smartest finance minds in the world think it is important to be cautious, we should probably listen. Rest assured there will be a time to be more aggressive, but these things will take some time to play out. Furthermore, the latest correction may be shallow and lead to much higher prices, only to have another epic crash. We just don’t know, therefore we will be prepared for either outcome.

For those with a plan, the lower prices are welcome. Nine months ago (1st quarter 2015) our newsletter provided a guidepost for preparing ourselves for the inevitable rollercoaster ride of the markets. It’s worth reading again.