03 February 2019

    Frankly speaking

    Yoga of the mind, fundamentals & the long term

    According to Abraham Lincoln “An Eastern monarch once charged his wise men to invent him a sentence, to be ever in view, and which should be true and appropriate in all times and situations. They presented him the words: "And this, too, shall pass."” Lincoln commented on the beauty of these words, “How much it expresses! How chastening in the hour of pride! How consoling in the depths of affliction!”

    What a wonderful sentiment and how relevant to all of us as investors. “This too shall pass” might just be the perfect way to think about the wild market gyrations of the past few months.

    I don’t think that the volatile markets experienced at the end of 2018 have passed just yet but you could be forgiven for thinking that they have.

    Markets bounced decisively higher in January as trade talks between China and the United States lurched towards a positive outcome and the US Federal Reserve softened its stance towards more restrictive monetary policy.

    The US S&P 500 share market rose 7.9%, its best January since 1987, New Zealand’s S&P/NZX 50 was up 2.0% with emerging markets like Brazil, up 10.4% and Korea, up 8.5%, even stronger.

    This, almost, euphoric strength in markets shall pass too. Just as I exhorted investors to remain calm during the dramatic sell-off during the fourth quarter, so too should we retain perspective during strong months like January.

    Investment success comes from being calm, doing meticulous research and letting the long run compounding effect of owning quality, growing businesses do its magic.

    That’s why we don’t spend our time chasing the market. This, in our view, is akin to trying to predict the unpredictable. Instead we calmly evaluate the competitive strengths of a business, looking to invest your money in firms that provide compelling value for customers and have business models that protect them from competition. 

    That said, we can’t ignore the broad environment that companies are operating in. The past ten years have been characterised by falling interest rates, more and more people getting jobs, a strong Chinese economy and improving consumer and business confidence. It was a fertile environment for company success.

    The next couple of years will be more challenging. With a more challenging environment, indiscriminately buying shares is not a strategy that will pay off. It is more important than ever to be selective.

    There are a few things we think will be critical to consider even more diligently than is normally the case:

    1. Identify companies able to deliver organic growth – if economic growth around the World is more tepid, as we expect, those rare companies that are able to grow under their own steam become even more sought after. Identifying these companies may be easier said than done. Strong economic growth can often give the impression that a company has strong underlying growth.  Once the supportive economy fades, sometimes so too does the apparent great growth story. Do your research and be selective.   

    2. Be humble in your forecasts – strong economies make heroes of all of us. A more challenging environment means we should be more humble in our outlook, having a balanced perspective on the outlook for a company’s earnings. Too optimistic and we will be disappointed. Too pessimistic and we miss opportunities. The glass is neither half full nor half empty instead it contains 125 mls of water. Seek to be correct and balanced in your views!

    3. Avoid debt – rising interest rates, more tepid growth and nervous financial markets are not the environment to invest in companies with too much debt. 

    4. Sensibly diversify – a more challenging environment means increased uncertainty. One salve to uncertainty is diversification. This doesn’t mean owning everything but it does mean owning some assets or companies that will do better if things are worse than we expect. Similarly it means owing some assets that perform well if things turn out better. Selective diversification is what I would call that strategy.

    As we head into what may well be a volatile year in share markets, we should resist the urge that the market’s roller coaster becomes an emotional roller coaster for us. Instead let’s adopt more of Lincoln’s wisdom.

    He famously noted “Give me six hours to chop down a tree and I will spend the first four sharpening the axe.” The metaphoric tree we are all trying to chop, is building our lifetime savings. Not reacting to markets emotionally, spending our time to research and prepare, in essence sharpening our axe, makes success that much more likely.