Tuesday, April 28, 2015

"Swing Thoughts" for this Market

            With apologies to the non-golfing readers, I am going to go with a golf analogy this quarter. We have, after all, just emerged from Masters week which is the equivalent of Holy Week for the avid golf fan. Years ago, I picked up a book by legendary golf teacher Harvey Penick called Penick’s Little Red Book. Penick’s resume included teaching many successful tour players like Ben Crenshaw, Tom Kite, and Kathy Whitworth while remaining an active instructor well into his 80’s. Despite Penick’s relative anonymity, the book succeeded, selling more than one million copies to become the best-selling sports book of all time.* Why? Because Penick’s teaching worked. It made the average golfer play better.

            Penick relied on short, memorable anecdotes to drive home important points. He gave his pupils a “swing thought” – the one thing they were to think about before stepping up to hit a shot. For example, when Penick’s student, Betsy Rawls was in a playoff for the 1951 US Open Championship he sent her a one-sentence telegram. It said: “Take dead aim!” This was her ONLY thought when she approached her golf ball. Betsy won the playoff.**

            Many golfers don’t experience similar success not because they lack talent, good instruction or sound equipment but, in large part, because the swing thoughts they have in their head before they bring the club back are wrong (or, perhaps, they have too many of them).  Likewise, individual investors don’t achieve the returns they should because of flawed thinking prior to and while they are deploying or monitoring their personal capital.  Barry Ritholtz, a leading Wall Street commentator and strategist, notes that since ERISA was passed in 1974 enabling IRAs and, eventually, 401(k) accounts, the market has returned about 11% annually.  However, the average investor has gained only 3% per year. ***  This is commonly known as the “behavior gap.”  Bad thinking leads to bad investment behavior in the same way that bad swing thoughts lead to bad golf swings.  In both cases, the result is bad.  In one case, the cost is some lost golf balls and a bad afternoon outside; in the other case, the cost might be a college tuition payment or a deferred retirement date, or worse.

            Just as people hired Harvey Penick so that they would score better versus how they might score without his input, we believe folks hire Punch and Associates so they might achieve better results versus what they might achieve without our involvement.  So what is the equivalent of a good swing thought for putting money to work or staying invested in THIS market?  We have several, in particular, for folks taking a passive approach toward overseeing the active management of their portfolio:
  •       Think “Zig,” think “Zag,” but mostly, think long term.
        "The market timers’ Hall of Fame is an empty room."   -- Jane Bryant Quinn
Despite having heard this quote early in my career, I had to lose some of my own money to realize the veracity of it.  Nobody on the Forbes 100 list got there by jumping into and out of businesses on a regular basis.  Why should we advise our clients to do differently?  We are contrarian investors, so it is in our nature to examine parts of the market that have a) attracted the least amount of attention, or b) declined recently or have not participated in the market’s advance.  In many cases, these areas have the most upside over our expected holding period.
  • Forget the headlines. 
         “News is to the mind what sugar is to the body.”   -- Rolf Dobelli (www.dobelli.com), 2010

I challenge anyone to name a time when you read a mainstream headline and it allowed you to make a better decision.Think of what it takes for something to become a headline.  Many people —not just one or two—have to be clubbed over the head with the effects of an issue or the concern over what might happen; they then  gather in a room discuss it some more, ping-pong the issue back and forth, and maybe table the headline for future publication.  Something more happens in the real world – stocks go up, stocks go down, the dollar spikes, oil crashes, etc. – and they decide to create the headline.  How is this headline going to help you?  The fact that it was created means that its effects have already been felt.  You can’t profit from it, and it will likely create unneeded angst.
  •          Volatility does not equal risk.  
With markets up and a Fed tightening in the offing, markets will no doubt fluctuate more.  Warren Buffett dedicated several paragraphs in his annual letter to the difference between volatility and risk.  He is the world’s most successful investor, and he does not buy into the conventional wisdom about it: “stock prices will always be far more volatile than cash-equivalent holdings.  Over the long term, however, currency-denominated instruments are riskier investments — far riskier investments — than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions.  That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk.  Though this pedagogic assumption makes for easy teaching, it is dead wrong:  volatility is far from synonymous with risk.  Popular formulas that equate the two terms lead students, investors and CEOs astray.”

Warren’s business partner, Charlie Munger, defines risk more succinctly: “using a stock’s volatility as a measure of risk is nuts.  Risk to us is 1) the risk of permanent loss of capital, or 2) the risk of inadequate return.”
  •              Don’t get too excited/depressed.

    “We have met the enemy, and he is us.”         -- Pogo, 1970
The market has recovered over 200% from its bottom in 2009.  That’s a 20% + annual return for the S&P 500.  Pretty exciting, right?  The previous 10 years (1999-2009) was different.  The S&P lost about one-third, or almost 4% annually.  Pretty depressing, huh?  Excitement causes people to want more of what excites them.  Depression causes people to want to stop the pain.  While these emotions are normal, acting on them with your money is not recommended.  Most of our clients have been with us during both of these historical periods, and we believe most will be with us during distinct periods which will evoke similar extreme emotions in the future.  This is when proper swing thoughts are critical.

*         Golf.com/instruction/Penick
      **     The Little Red Book, Penick 1992
     ***    www.ritholtz.com/blog