Thank you for all of the guesses to last month's ARCUS question.
The answer is SAP!
In this month's ARCUS, I will share from my 25 years of markets experience my humble opinion on how to survive market tides. I will try to cover the When, Why and How of them. Also, my own buoyancy techniques.….I won’t let you sink… rest ashore(d). 😉
Credit: Daniel Vasconcellos
Tides come and go......its chopsticks, plastic shoes and limitless ladders you should appreciate.
In the words of Warren Buffet, who succinctly described a professional investors dilemma, “only when the tide goes out do you discover who’s been swimming naked." This being a reference to the true worth of companies being shown in market downturns. Since 1998 I have seen at least 7 instances when the world’s financial markets have taken a serious tumble (almost 15% or more) and we have seen what our investments are truly worth. Following are 7 instances over the last 20 years that I recall as market tides receding. I have used the MSCI All Country World Index (MSCI ACWI) as a proxy for global equities. The numbers are not pretty.
March 2000 – March 2001 -26% down
June 2001 - Sep 2001 -17% down
March 2002 – Sep 2002 -25% down
Sep 2007 – March 2009 -50% down
March 2010 – June 2010 -14% down
March 2011 – Sep 2011 -16% down
October 2018 – Dec 2018 - 14% down
Given the above numbers, you are right to ask, why bother? It’s all a matter of perspective. If you were invested in most European markets or Japan, then 20 years on your returns maybe as good as inflation in US$ terms. On the other hand, the three US markets, Nasdaq, Dow and S&P would have doubled your investments every 7, 10 and 11 years respectively. Adding EM into the picture and investing in a global index like MSCI ACWI would have seen you double your money every 12 years. All in all a lot of effort to fighting tides with little gain you could say. Lets not give up yet, lets try to understand tides before we decide to sit on the shore. If you do decide to sit on the shore then I have just what you need to keep you company… more on that later. Almost all high tides in equity and financial markets have been inspired, coerced, engineered or even deluded. Whatever the reason and who got it right, generally people don’t care. Many think we are in such a high tide right now. US equity markets are setting new record highs, while bond market yields already set record lows (price highs) during QE. This time the high tide in financial markets has been inspired by technology, coerced by disruption, engineered through QE (cheap money) and is deluded by our own inherent nature to dream (unicorn/decacorns) value when growth is without profit. Calling this a high tide is no big feat, however predicting when the retreat to low tide will start and how far the low tide will go, almost impossible. How do you know when the tides will leave and how far back will they go? I cannot claim to know the answer of when and how far but as someone who has lived through all of the above drawdowns as a professional investor, I have some muscle memory on what factors play a role in tides and their movements. THE WHY OF TIDES… rather than any philosophy we should just rely on physics and gravity… what goes up must come down and vice versa. THE WHEN OF TIDES…is the hardest question. When will the tide start retreating thus taking backwards even the best of companies. Lets examine history...
March 2000 – March 2001 - 26% down - Dotcom I
June 2001 – Sep 2001 - 17% down - Dotcom II
March 2002 – Sep 2002 - 25% down - SARS
Sep 2007 – March 2009 - 50% down - GFC
March 2010 – June 2010 - 14% down - EUR crisis I
March 2011 – Sep 2011 - 16% down - EUR crisis II
October 2018 – Dec 2018 - 14% down - Fed Tightening
Many a market strategists have made or lost a career in attempting to predict the next cause. Identifying THAT STRAW that breaks the camel’s back is almost impossible. For every strategist or fund manager that has called one such break point, they have almost always missed the next 3. Amongst the many lead indicators of the high tide reaching its peak, listed profits as a share of GDP are at all time highs – we saw that in 2001, 2007 and almost NOW. Also, forecast profit margins (especially US) are at all time highs – 2001, 2007 and NOW seem the most credible. Again, these have only presented themselves at 3/7 last tide outs. Even our own bottom up company research also suggest excesses, as we have a watchlist of companies we would like to own which is twice as long as our portfolio but is trading at a 36% premium to our portfolio. Rather than worry about when, maybe try how far back the tide goes? THE HOW FAR BACK OF TIDES… Some investors rely on technicals to determine the pain in low markets, others sentiment indicators, some rely on corporate M&A to show destressed value while others rely on behavioral finance to help give them comfort to jump back in. Valuations of markets in aggregate are often cited as reasons for fear or greed, most often wrongly so. I believe the energy expended, time taken and decisions executed in fighting the tides of markets is often dictated by the need to beat some benchmark, some index, which means you are either too early in leaving the market or too early in getting back into the market as the tide goes out. These are again a professional investors dilemma especially those worried more about the market/indices and benchmarks, not the companies they invest in. At Panarchy Partners we are index agnostic and thus use our valuation and price targets on companies as entities to determine entry into a company we want, not to play some game of tides. Now, given my experiences above you rightly ask me, why bother with the tides? You are right. Don’t bother with market tides. Its best not to go swimming with the masses in the markets, nor tirelessly fighting the tides defined by indices/benchmarks and worrying about rip currents that are unpredictable and dangerous. Best to stay on the shore, find and engage with a few companies who appreciate chopsticks, plastic shoes and limitless ladders, better to keep things in the open rather than wait for the tide to go out. We have found such partners, whose value is for all to see and while tides come and go, the surprise of swimming naked is rarely suffered. Our Global Panvest Portfolio has 23 such companies, and if you had invested in them, on average you would have doubled your money every 6.5 years for the last 20 years, regardless of market tides. Chopsticks, plastic shoes and limitless ladders – you ask? Last year the use of chopsticks in an advertisement in China exposed how a company can be clueless about its customer’s culture and lose its social license to operate overnight. Companies that have accepted the fact that they have more stakeholders than shareholders are the ones that will not self implode. They are the ones who will manage market share gains even as tides go out. Respecting and nurturing social capital should be your beach buddy’s traits. It’s a must in our panvesting process. As much as barefoot beach walks are great, we need to look for companies with plastic shoes. Yes, companies that have taken environmental problems and converted them into solution, while still delivering on financial returns. 5 million pairs of shoes from recycled plastic from the ocean wasn’t good enough, so this one company is making 11 million this year. Environmental costs and opportunities can only be identified by companies themselves and not by a benchmark or index. Companies with environmental impact strategies that minimise costs and potentially generate revenue while doing good is what will keep us agnostic about tides/markets. Having them at your beach cricket game will make for better results. Last but not least in the decades to come, the future of work place is going to change. Companies with limitless ladders for their human capital to climb will see financial improvement on many fronts. Organisational structures that still maintain glass ceilings, gender gaps, lack of diversity, inflexible and inhospitable working conditions and most of all limited upside will demotivate and undervalue human capital. As panvestors we see human capital as having the most upside for a firm, especially when combined with innovation. Viewing equity returns through benchmark and indices will always give you a feeling of tides making or breaking your fortunes. It’s better to stay grounded on the shore with respectful and resilient companies that deliver progress and return on all forms of capital beyond tides, for the long term. With chopsticks, plastic shoes and limitless ladders, sustained financial returns from panvesting come on the back of all forms of capital, not at the expense of other forms of capital. Become a Panvestor…. Don’t stay focused on just one thing. Happy Panvesting! Munib