MARKET VIEWS

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"The capitalist must have fine hearing and a thick skin;
must be simultaneously cautious and venturesome, a swashbuckler and a calculator,
careless and prudent. He must develop all the qualities of an experienced man of business."
 -Karl Marx - Kapital

The Mystery of Things….. After a summer rally propelled the major stock indexes to near-record highs, the markets slid in September, with the Dow Jones Industrial Average and the S&P 500 suffering four straight weeks of losses. The S&P 500 was down 3.9% in September, its first monthly loss since March when the pandemic began.

Rising coronavirus infections in Europe and elevated case levels in the U.S., combined with the likelihood Congress won ’t manage to pass new stimulus by November's election, has crimped investor confidence and put the markets in a holding pattern.  The cumulative risks of Covid-19, the potential for political instability in the US, and signs of lagging economic growth are all making it harder to stocks to see further gains.  Overall, the daily fluctuations in Q3 has actually seemed well-calibrated, rising or falling in accordance with unfolding information about the pandemic, and its associated economic impact.

For Q3, the equity markets defied the pandemic and turned in a bullish quarter. The S&P 500 rebounded by 9.3% and is now +4.1% for 2020 YTD; the DJIA rose 8.7% but remains -2.7% below breakeven for the year.  The tech-laden NASDAQ shot up 10.4% and is the conspicuous winner in the US market, and globally as well.  Internationally, the MSCI World Index and EAFE Index rebounded in Q3 and are now +0.4 % and -8.9% YTD, respectively. Among the major international markets, China is the one standout, with the Shanghai Composite +5.5% YTD.  China’s resilience, as the first country to suffer from the coronavirus and then bring it under control, has had a leavening effect on global markets. Accordingly, the yuan closed out its strongest quarter against the dollar in more than a decade.

The US major equity indices continued the historic stock market recovery that has confounded investors with its sheer velocity and strength. The market’s star performers continue to soar ahead, creating an ever growing divide with the majority of laggards. Dominating the vanguard are technology and biotech companies, as well as firms that have benefited from the Work-From- Home trends. The lackluster economy - along with the dearth of high-return alternatives, including bonds - triggered a rush into companies that can still prosper under pandemic conditions and promise high growth in the future.  How much more can the expensive growth stock technology giants (i.e. FAAMNG stocks) and the newer cloud-based and SaaS software companies drive the market indices forward while the overall economic recovery gains traction?

On the credit front, in Q3, the continuing rebound in equity prices and the Federal Reserve’s standby intervention in the bond market has fueled market confidence. A significant driver of stock prices is the huge amount of liquidity that the Fed is willing to inject into the financial system, in an effort to counteract the depressive economic impact of the virus.  The Fed’s aggressive willingness to purchase bonds has provided unprecedented price support to fixed-income investors.

Looking ahead for the balance of 2020, there are plenty of potential challenges ahead. This year has indeed been a tumultuous one.  As one wry pundit noted: “I am involved in the stock market, which is fun, and sometimes very painful.”  As the pandemic continues to dominate headlines and the race for an effective vaccine continues, expect significant market volatility. The gross uncertainties of the upcoming November presidential election are spurring investor bets on market volatility that will ripple widely in the options, currency and bond markets through the end of the year. While markets are likely to remain volatile in the fourth quarter, it is important to recognize there are tail risks in both directions. Apart from downside risks discussed above, there are also upside risks from vaccine development and stronger-than-expected monetary and fiscal support, which could swing the market the other way. On balance, we are heartened by the resilience of the US economy in the face of great challenges, and remain optimistic that a substantial economic recovery will emerge in 2021.

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What the Stoics Can Teach Us About Investing…..To invest successfully necessitates the right philosophy. There is no magic formula. However, there are time-tested habits and traits that can be applied to our portfolios that have validity and actually work.

Epictetus has said: “It ’s not what happens to you, but how you react to it that matters.”  This regulation of reaction and perception is a core aspect of Stoic philosophy. We can ’t control the market or the behavior of other investors. But we can always control how we respond, and that determines our results.

Long-term investing is a process that demands patience, discipline and a certain degree of adventure. Along the way, we learn to listen carefully to market data and market action. Listening is a powerful skill. To stand apart from the majority, we must become good listeners.

Successful investors have a distinct direction in life, and a purpose. Why do we invest? What is our objective? Seneca, the great Roman stoic philosopher advises: “If one does not know to which port one is sailing, no wind is favorable.” Accordingly, investors who rise above the masses, who achieve sustainable desired results, know the answers to these questions.

Seneca also said that no one has ever been wise by chance. Wise investors do not rely on luck, although he gladly embraces it.  Luck is a very fickle mistress. Luck plays some role in investing but most of the time it is a result of hard work, diligence and patience.   True good fortune is what you make for yourself. Good fortune is a function of good character, good intentions, and good actions.  Even when luck abandons you, you are only as miserable as you think you are.

An investor who thinks he knows it all, is not only foolish, but an incalculable idiot. As Epictetus has said, a great person is the one who accepts the limits of his or her knowledge. “It is impossible for a man to learn what he thinks he already knows.” Successful investing fosters a particular kind of thinking, which is the capacity to observe and reflect on how one thinks. Thinking about thinking involves a freedom to think from multiple perspectives. It means having the capacity to consider conflicting thoughts and experiences and hold a lively space for the differences. These traits are captured in Marx’s description of a good capitalist cited at the beginning of this essay.

Great investors take responsibility for their wins and failures. They radically protect their focus. The value of attentiveness varies in proportion to its object. You ’re better off not giving small matters more time than they deserve. Our focus is only as valuable as what we put it on. Do not waste your focus on little things. Long term investors respect their focus, protect it, and ensure that they devote their energies on what matters most.

Wealth is not just money. Wealth is a mindset. Philosophy has long recognized this truth. Epicurus advises: “Any man who does not think that what he has is more than ample, is an unhappy man, even if he is the master of the whole world.” Especially in our consumerist culture, more and more people find that their possessions are not enough, and keep chasing more. Epictetus, who was born into slavery, said that wealth consists not in having great possessions, but in having few wants. And when asked who is rich, he said this: “He who is content.”

Finally, remember this: you do not need to be a multi-millionaire or a billionaire to be successful. Possessions, success, power, fame — it all falls short, if you are in it alone and have no one to share your happiness and sorrows. Be generous to yourself and to others, and good karma will accumulate in your wake.

"To think is to confine yourself to a single thought
that one day stands still like a star in the world's sky."
 -Martin Heidegger 
 

On The Way to a Recovery….. So much to say, but also so much confusion and uncertainty.  How does one find clarity?  The hoped for V-shaped recovery（transitioning into a W-shaped recovery) in the stock market has confounded the experts, humbled naysayers and generally leaves the market cognoscenti shaking their heads.  That the market indices is decoupled from the current economic situation is not so much disputed as why this phenomenon is occurring?  Stated simply, the market - in its typical oracular fashion - is looking past the erstwhile economic and financial devastation, and discounting a recovery over the course of the next 24 months.

This pandemic crisis was unprecedented, with a dramatic downturn which will be followed by an equally dramatic recovery.  The depth and duration of the economic collapse will likely not be prolonged, given the strength of the economy going into the crisis and the relative stability of the financial system.  Nevertheless, the path of the recovery remains difficult to track, and much will depend on the development of a vaccine as well as whether future waves necessitate subsequent lockdowns.

For Q2, the S&P 500 rebounded by 19% and is now only -4% for 2020 YTD.; the DJIA rose 16.5% but remains -11% below breakeven for the year.  The tech-laden NASDAQ shot up 31% and is the conspicuous winner in the US market, and globally as well.  Internationally, the MSCI World Index and EAFE Index cut their YTD losses in Q2 and are now down 6% and 12%, respectively.

How much more can the expensive growth stock tech-goliaths  (i.e. FAANG stocks) drive the market indices forward while the overall economic recovery gains traction?  Is there enough cash on the sidelines and will widespread investor caution be sufficient to cushion the inevitable market pullbacks?  Right now, the median S&P 500 stock trades at nearly 20-times forward earnings – expensive in the absolute, but justifiable if corporate profits rebound quickly, especially when mitigated by compressed corporate debt costs under a near-zero Fed policy stance.

On the credit front, in Q1, liquidity concerns and credit infrastructure stresses rendered most credit-based trading prices (other than Treasury and agency-backed securities) at distressed levels.  The rebound in equity prices and the Federal Reserve’s intervention in the corporate bond market has fueled market confidence.  A significant driver of stock prices is the huge amount of liquidity that the Fed has injected into the financial system, in an effort to counteract the depressive economic impact of the virus.  The Fed’s aggressive willingness to purchase bonds (including high yield bonds) has provided unprecedented price support to fixed-income investors.  It has been a startling sequence of events to pivot from stress in the bond markets to a period of historically low interest rates.  Mirroring the stock and bond markets, the US dollar volatility has turned into calm, leaving the USD +1% this year against a basket of other major currencies.

As the pandemic continues to dominate headlines, investors are forced to grapple with a new normal amid social distancing and self-quarantine edicts.  Expect continued significant market  volatility.  We nevertheless  remain optimistic that our lives will gradually return to normal, although the lingering effects of the virus on our healthcare system, businesses, and financial markets will be determined by our success in social containment and ongoing monetary and fiscal action to support a substantial recovery.

During this strange period, although Wall St. block traders and Robinhood day-traders grab the headlines, the overwhelming majority of mainstream investors stayed the course during one of the most frightening bear markets in decades.  The broader investment public has finally learned that stock investing is a long-term endeavor.  Although there has been plenty of anxiety, being patient and not over-reacting has proven to be the wisest path to capital preservation and wealth accumulation.  Perhaps Jesse Livermore, the infamous plunger of the 1920s, said it best:  “It was never my thinking that made the big money for me.  It was always my sitting.  Got that?  My sitting tight!”

Although this author has often derided the sometimes schizophrenic nature of market action,  the daily fluctuations in Q2 has actually seemed well-calibrated, rising or falling in accordance with unfolding information about the pandemic.  However, against this backdrop is another wild card, namely, the epically grotesque, near-comic leadership emanating from Washington.  Instead of providing the steadfastness and seriousness that this crisis demands, what we have seen instead is an obsession with searching for scapegoats, coupled with a neurasthenic grasp of the facts.  This kind of political malpractice is far more damaging to investors’ psyches than the drum roll of bad economic statistics.    Nietzsche’s description of deranged thinking could well be applied to our demented leadership today:  “Whosoever fights monsters should see to it that in the process they do not become a monster. And if you gaze long enough into the abyss, the abyss will gaze back into you.”

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What Calls for Thinking?…..

The history of the stock market is the history of forgetting!  This radical failure of remembrance, so characteristic of these times, constitutes the danger that threatens investors and the markets in an age obsessed with technology and data proliferation.  Just as each new generation of young investors are stunned by a new bear market that envelops them, they subsequently ruefully discover that they never even learned the lessons of the market panics of previous decades. Thus the current generation of young inexperienced investors is the culminating but perfectly logical product of this amnesia.  In the same vein, it is not surprising then that the Covid-19 pandemic of 2020 caught the world oblivious to the history of the 1918 Spanish flu (in which millions perished), much less to the more recent scares brought on by the Ebola and SARS viruses.

But what does “thinking” really mean?  The conventional response is not difficult to answer.  Thinking conjures up calculating, reckoning, figuring, planning and problem-solving; in less earnest moods, it involves phantasy and daydreaming.  Thinking is having ideas or a vision in your mind.  Thinking is what we do when and while we are doing something.  Of course if we think too much, we will never do anything.

But in another context, this question is no so easily answered.  What calls on us to really think? This alternate approach places a radiant obstacle in the path of the obvious.  Perhaps we need to assert less, listen more, and let the data guide us to the truths of the marketplace?  Here we do less problem-solving and pay more attention to the way the problem poses itself.  It is a kind of “poetical” thinking.  Our logical and technological training does not prepare us well for such thinking.

At first, we need to “unlearn” habitual responses to conventional questions, refrain from anodyne answers in the face of market conundrums.  The implication is that calculative kinds of thinking, however vital to the conduct of the quantitative sciences, do not fulfill all the requirements of an investor’s thinking nature when it is applied to the subjective, organic and all-too-human arena of freewheeling, auction-style markets.  The financial markets is a domain of agonistic struggle. What is called for is another kind of thinking, whose object is in perpetual motion, and which can be of consequence only if it pays heed to its own movement and underlying motivations.

The market makes demands on us to which we are not equal.  It compels us to think about what is most thought-provoking.  It puts us on the defensive.  It humbles those who fail to learn from stock market history.  What is it that enjoins investors to place our wealth - along with our egos and mental energies - to further the pursuit of our financial destinies?  Asked in such a way, this question points us to the task of thinking and the calls for remembrance.

Perspective is one of the intangibles that veteran investment advisors bring to the task of investment management.  It is crucial to remember that bear markets do not destroy wealth.  How we behave during bear markets is what destroys wealth. Human nature rarely changes, but the distribution of human wealth certainly does.  In the midst of the coronavirus crisis and its attendant economic and market tumult, forbearance and positivity must be balanced with realism and prudence.  Heidegger reminds us that “thinking holds to the coming of what has been, and is remembrance.”

"We are groomed to deal with adrenalin, anxiety, bull markets and bear markets.
But when health and welfare is involved and people's lives are involved, that eats away at our spirits."
 -NYSE floor trader 
 

Drawn and Quartered….. The major market indices suffered its worst Q1 ever.  In all respects, it was a Sisyphean quarter!  The year 2020 is the year of the coronavirus, likely to go down in history as a milestone in world affairs.  The atmospheric uncertainty generated by the COVID-19 outbreak has wreaked havoc on the economy, the healthcare system, and the collective psyche of the public, not just in America, but across the globe.

To paraphrase Tolstoy, bull markets are all alike; but every market panic is panicky in its own way.  In 2011 and 2018 when the broader market felled nearly 20%, the key triggers were a downgrade of U.S sovereign debt ratings and the impact of the U.S. China trade war, respectively.  Stepping a bit further back in recent history, in the first two decades of this century, a number of unforgettable catastrophic events rocked the markets - 9/11, the 2008 Great Recession - although none of them has had the comprehensive global financial and human impact of the COVID-19  pandemic.  While each of the aforementioned cataclysms came with their own set of fears and challenges, the respective dangers were clear. With a pandemic, the danger source is potentially any one of us. Suddenly those who are typically around us can become a potential threat.

Many years ago when I was still a neophyte investor during the halcyon years surrounding the 1987 Black Monday crash, one of the mordant witticisms bandied about was that “the market was consolidating at a lower level.”  During the horrific quarter that just ended, a joke was circulating that a 1,000-point Dow move was the new 100-point day.  To point out the extreme Great Depression-like volatility of recent market action would be akin to a high Japanese government official saying at the end of WWII that they “had not necessarily won the war.”  But all jocularity aside, this has been no laughing matter.  The coronavirus-induced market tumult has rendered recent investing into more an act of passion than an act of logic. Wall Street has typically resorted to gallows humor when faced with market panics; but a morbid turn is still better than standing on the window ledge.

In the market crash of Q1 2020, stocks declined at the fastest pace in modern history, surpassing  even the 1987 Crash and the Great Depression.  From Feb.19-March 23, the S&P 500 plummeted 34%, vaporizing three years of gains in one month.  Less obvious but just as devastating was the systemic seizure in the credit markets, the bedrock that supports most investment products. In search of a safe haven, investors rushed into cash, gold and Treasuries, pushing the 10-Year yield down to an unprecedented 0.69%.  Finally, funding shortages around the world fueled a flight to dollars, powering the US currency to an 18-year high.

When the books mercifully closed on Q1, the S&P 500 declined by 20.0%, followed closely by the Dow at -23.2% and the NASDAQ at -14.2%.  Most other international equity indices fared even worse.  Amid the carnage, the financial sector (-32.3%), real estate (-29.2%) and crude oil (-66.5%) bore the brunt of mass selling.  Even the historically defensive utility sector fell -14.0%.  Liquidity concerns and credit infrastructure stresses rendered most credit-based trading prices (other than Treasury and agency-backed securities) reflecting distressed levels.

For most long-term investors, it is too late to sell but also too early to buy. As the coronavirus outbreak continues to dominate headlines and hospitals, investors are forced to grapple with a new normal amid social distancing and self-quarantine edicts.  As markets  fluctuate wildly and the government deliberates on further stimulus packages, there is great speculation when this period of volatility and uncertainty will end. There is a wide range as to the various downside market scenarios given our current understanding of the virus, health policies, and monetary and fiscal responses. Eschewing both denialism and panic, we nevertheless  remain optimistic that our lives will return to normal eventually, but the lingering effects of the virus on our healthcare system, businesses, and financial markets will be determined by our success in social containment and unprecedented monetary and fiscal action to support an eventual recovery.

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Acts of Passion Versus Acts of Logic….. As the spectre of death spreads across the globe - Appointment in Samarra-style - this author mulls the most appropriate perspective to address our current anxieties. One might not be afflicted with the virus but it is a virtual certainty that your portfolio is sick.  It’s one thing to ask whether you should panic about the coronavirus.  It’s quite another to ask whether you should panic about the stock and bond markets.

America’s stock market, our swaggering symbol of financial health and promise, has devolved into a neurasthenic borderline basket case. The cataclysmic changes during these past few weeks have been a shocking and humbling reminder of how fragile our markets are, as we see our entire ecosystem disrupted when confronted with a deadly pathogen in our midst.  Market panics typically trigger hysteria, but it is also an apt time for introspection.  So when did the investment world become so existential?

To paraphrase Camus, there is but one serious investing problem, and that is whether to risk one’s hard-earned money or not?  Judging whether or not it is worth exposing a substantial portion of one’s equity to the unpredictability and vagaries of global auction markets amounts to answering the fundamental question of investing.  All the rest - whether it is asset allocation, market timing, stock picking - comes afterwards.  These are compelling questions one must answer, especially  when one is in the eye of a global health crisis and concurrent financial meltdown.  At the most basic level, it is the perennial struggle between fear and greed:  the risk of losing large amounts of money due to the pandemic, versus the risk of missing out on a dramatic rebound when the virus abates.

Sometimes the boundary between passion and logic becomes irretrievably blurred. Adverse investment consequences can be more readily absorbed when an action is the outcome of an act of God or a “black swan” event, rather than one’s own actions.  If an investor deserves our respect, he must lead by example.   Such a definitive act belie impulses the heart can feel; yet it demands careful study before it becomes clear to the intellect.

Stock market crashes and financial credit dysfunctions induce extreme personal stress which, in turn, reduces our capacity to make smart rational choices.  Our cognition, perception and attention all become impaired. Our biases  turn negative and we become unduly influenced by the crowd, irrespective of objective information.  High stress impedes our memory and our ability to think flexibly.

When markets are in chaos, the only controllable variable is one’s own investment behavior.  To address this human reaction, one must simplify the tasks at hand and insulate oneself from other people’s panic.  Resist the contagion of the mob’s panic by resorting to whatever personal structure and routine that can offer solace.  Take small steps rather than large leaps, and reduce the emotions from the decision-making process.

The professional investor class has long subscribed to the conscious rational decision-making process.  This has subordinated the key role of subconscious processes at work.  We sometimes trust our intuition or gut more than our rational decisions because they seem more revelatory. However when our conscious and subconscious inclinations conflict, it is usually better to pause and dwell upon both preferences.  In moments of uncertainty, being open to subconscious and conscious thought to address a big decision may yield a more manageable outcome.

Capital preservation or capital growth?  Rational decision-making is utilized in assessing large amounts of information with disparate choices, while the subconscious may be more attuned to sensing risk, especially when our choices have significant consequences for others.  This, of course, is the default position for investment managers and substantial investors; one that is ours to humbly bear during these trying times.

Hope and optimism is essential to the process of investing. Like the phenomenon of romantic  love, market participants enjoy a unique sense of heightened arousal when the anticipated outcome can be either joy or misery.  By necessity, the outcome is not assured.  There is indisputably a large element of excitement and risk in this game, and human beings seem willing to pay a large price for playing it.

A parting thought:  in Camus’ 1947 novel The Plague, he suggests that a deadly crisis brings out people’s best qualities.  We then return to normal life with a clearer vision and deeper understanding of the precarious nature of both markets and, alas, human existence. At the novel’s conclusion, he writes:  “what we learn in times of pestilence is that there are more things to admire in men than to despise….By refusing to bow down to pestilence, they strive their utmost to be healers.”

"I built a career out of knowing what I don't know."
 -Jack Bogle
 

The Shadow of the Object ….. Stocks ended the year and the decade at record highs.  In fact, both stocks and bonds achieved the largest simultaneous gains  in over two decades.  In 2019, the S&P 500 soared 28.9 % while the 10-Year Treasury Note  rose  11% (with an equivalent yield of  1.9%).  High yield bonds returned +14.4%.

Stocks rose steadily during Q4 once the Federal Reserve began cutting interest rates. The major indices enjoyed their best annual performance since 2013 and punctuated a strong decade of out-performance.  The S&P 500’s roughly 190% gain for the decade is the best since the 1990s. With the immediate crisis of trade wars behind us, investors embraced improving signals of economic growth and the expectation that the Federal Reserve will hold interest rates steady.  Cautious investors, fearful of missing out on the action, threw in the towel and got off the sidelines.  In global markets, the EAFE rose 18% for its biggest gain since 2009, and the Shanghai Composite gained 22%.

This year’s extraordinary rally across most asset classes caught risk-averse investors off guard.   Ironically, this reluctant rally is constructive as it signals moderation and indicates that there is still plenty of idle cash on the sidelines.  The S&P 500 now trades at 20x forward earnings, an arguably justifiable valuation considering that 10-Year Treasury yields are at 1.9%, the same level as the S&P’s dividend yield.  This is essentially supportive for stocks over the near term.

Going into 2020, we hold a constructive view on the markets' risk and the economy, given very low unemployment in the US, fiscal stimulus in Japan, China and Europe. Moreover, there are negative real interest rates everywhere and absolute rates in many countries. Finally, technical are good, breadth is at an all time high, the economy is strong, and there's a de-escalation of the trade war.

We continue to seek greater resilience in our portfolios, willing to forego some incremental return in exchange for a margin of safety.  This means favoring U.S. large-cap quality companies with robust profit trends, high dividend yields and low debt levels. We also anticipate that there will be some regression to the mean, given US equity outperformance versus global stocks in recent years.   Hence, we tilt towards international diversification since foreign stocks (e.g. Japan, China) on average have lower valuations and higher dividend payouts.  Finally, we remain ever cognizant of what we do not yet know.

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The Unthought Known….. The psychoanalyst Christopher Bollas has posited, in his theory of the “unthought known,” that human beings at a very early stage are informed by many ideas conveyed through action rather than thinking.  This then becomes a part of our unconscious perception, organization and risk preferences that profoundly affects our conscious decision-making throughout adult life.  As adults, we spend our time looking for objects of interest (a “transformational object”) which can enhance our particular idioms or styles of life.  This is an important aspect of maturation, progress and productivity.

The professional investor class has long subscribed to the conscious rational decision-making process of stock selection, and more generally, asset allocation.  This has subordinated the key role of unconscious processes (sometimes colloquially known as intuition and gut) at work.  We sometimes trust our intuition or gut more than our rational decisions because they seem more romantic and revelatory.  This is evocative of the so-called Keynesian “animal spirits” that drive market valuations higher. However when our conscious and unconscious inclinations conflict, it is usually better to pause and dwell upon both preferences. In moments of uncertainty, using unconscious and conscious thought to address a big decision often yields the best outcomes.

The connection between conscious and unconscious decision-making and risk-taking are complex, with multiple pathways for communication and feedback.  Rational decision-making is effective in assessing large amounts of information with multiple choices, while the unconscious is better at sensing risk, especially when our choices have significant consequences for others.  This, of course, is a common situation for investment managers and other investors.

Often, our conscious mind will have too much information, in the absence of any clear choices.  Many investors have difficulty when presented with too many options.  Most professional investors are already trained in rational decision-making so this will satisfy our conscious minds.  As for our unconscious predilections, it is important to understand that they are strongly influenced by past subjective experiences and prevailing emotions that are subject to change.  Hence it is better to defer important decisions, if possible, during periods of stress, fear or anger.

Finally, one cannot listen one’s own intuition if it is drowned out by other people’s opinions.  After assessing available information and seeking external guidance, there comes a point to stop, reflect and listen to one’s own voice, one’s own “human idiom.” 

"The main vice of capitalism is the uneven distribution of prosperity.
The main vice of socialism is the even distribution of misery."
 -Winston Churchill 
 

Full of Sound and Fury, Signifying Nothing….. Q3 2019 ended little changed from the prior quarter, although there was plenty of intra-quarter action in both directions. Although the benchmark S&P 500 eked out a small gain of +1.2% for Q3, and the YTD gains remain at a startling  +18.8%, investors are anxiety-laden rather than euphoric.

As we assess what may happen in financial markets over the next few months, memories of what transpired in Q4 2018 are still fresh. Evaluating recent portfolio performance based only on 2019 YTD results is misleading because much of the return is just due to a reflexive bounce back from the steep December 2018 sell-off.  US equity markets have effectively been directionless for at least the past year. They’ve been stuck in a range, buffeted by both good and bad news on the economy and trade.

Although the markets have demonstrated remarkable resiliency, Q4 2019 might be a different story. October has historically been the most volatile month.  There are plenty of risks that can lead to a repeat of Q4 2018, including upcoming trade talks, Q3 earnings reports and President Trump’s impeachment saga. Looking ahead to the next few months, we see three factors continuing to drive markets:  geopolitics and trade; economic data; and the Fed.  In our view, US-China trade negotiations are the clear drivers.  Yet it’s hard to have much conviction on any particular scenario.  The markets could look past the trade and political risks if economic growth clearly start to accelerate, especially outside the US. But that’s unlikely as long as trade uncertainty that’s weighed heavily on manufacturing activity continues to linger.

The 2019 U.S. stock rally is occurring in spite of aroused fears of a weaker economy and surging bond prices.  To a lesser extent, international investors have also benefited, as the MSCI World Index, EAFE and the Emerging Markets Index have risen by 15.7%, 9.9% and 5.4% YTD respectively. The high yield bond sector continued its robust performance, returning 11.2% YTD. Stocks are still hovering near records, but many investors are pessimistic.  Investors remain obsessed with the trade war between the US and China, as well as a looming recession.

Going into Q4, we are increasingly defensive, selling low conviction positions and raising cash.  An expensively valued stock market, coupled with weakening economic fundamentals, warrants caution.  Accordingly, we still lean towards defensive sectors such as utilities, REITs, consumer staples, high-dividend equity securities, and high-yield bonds. While central banks can put a  floor under markets, we do not believe they have the capacity to push stocks significantly higher in the short term.  Currently, we prefer US equities versus Eurozone and emerging markets equities. That notwithstanding, we are neutral on US stocks, while favoring income-generating strategies.

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La Chute Encore?….. At the start of 2019, we expressed our preference for defensiveness, lower relative volatility and incrementalism.  Although economic conditions are still sanguine, we continue to seek greater resilience in our portfolios.  This means favoring U.S. large-cap quality companies with robust profit trends, high dividend yields and low debt levels.   We also tilt toward international diversification since foreign stocks on average have lower valuations and higher dividend payouts. Finally we continue to maintain above-average cash reserves to increase our short-term flexibility.

Veteran investors are rightly superstitious about heightened market volatility as we head into fall.  Right now market psychology is balanced on the edge of a a slender fulcrum.  Trump’s gift of tax cuts and deregulation are negated by the never-ending trade wars and recurring outbreaks of presidential scandal.  Stocks have struggled to move higher than their summer peak. Trade tensions have been a headwind, but investors are also concerned that there might not be enough monetary room left for policymakers to enact stimulus and keep the economy from heading toward a recession. The world economy will likely need to rely on monetary policy to help mitigate the current growth slowdown.  Incredibly, approximately $15 trillion in government debt globally now have negative yields.  The world is running low on yield.  Practically speaking, this means that investors really have no constructive place to go, if they are not prepared to expose themselves to the vagaries of the equity markets.

In summary, a lot can go wrong in Q4.  Market pundits and self-styled market gurus almost always underestimate the unpredictability of human behavior and the fallibility of markets.  Forecasters want to conceive of economic knowledge - financial analysis, business cycles, capital markets - as factual and objective; but the vast idiosyncrasy of individual choices and mob psychology largely undermines any model of financial investors as rational decision-makers.

"Established patterns, incapable of adaptability, of pliability,
only offer a better cage. Truth is outside of all patterns."
 -Bruce Lee
 

Whipsawed:  Two Steps Forward, One Step Back….. Up big in April, down big in May, back up big again in June.  What does it all mean, anyway? In Q2 2019, the S&P gained 3.8%, and at 17.4% YTD turned in its best H1 performance since 1997.  This steep rebound builds upon a  strong Q1 increase in global equity indices. Yet once again, investors were subjected to the bipolar vacillations of Mr. Market.

The stock rally occurred in spite of aroused fears of a weaker economy and surging bond prices that typically is predictive of a recession. The 10-Year Treasury note’s yield fell to a stunning 2.0 yield during the quarter, reflecting the Fed’s pivot towards possible interest rate cuts later in 2019.  So far, YTD market action has been vexingly counter-intuitive:  bond yields are falling because of a weakening economy, but lower rates and the Fed’s more dovish stance has injected the equity markets with a renewed sense of optimism. This has been most evident in the NASDAQ rising by 21.6% YTD as Big Tech is less dependent on overall economic growth.  Low bond yields have also been a boon for dividend paying stocks as well.

Meanwhile, international investors also joined the party, as the MSCI World Index, EAFE and the Emerging Markets Index rose by 15.6%, 11.8% and 9.2% YTD respectively. The high yield bond sector continued its robust performance, returning 10.0% YTD.

Stocks are hovering near records, but many investors are the most pessimistic they have been in years. This phenomenon is positive for equities since most bull cycles end in the midst of euphoria, not skepticism.  Investors remain obsessed with the trade war between the US and China, as well as a looming recession. In 2019, the key to both the US and international equities is China continues to rest on a reasonable resolution of the trade wars. We expect China to maintain its controlled expansion. Our market agnosticism notwithstanding, there is still a case for cautious optimism. The key issue for investors now is to be aggressive or defensive?  An expensively valued stock market, coupled with weakening economic fundamentals, warrants caution.  Accordingly, we still lean towards increased exposure to defensive sectors such as utilities, REITs and consumer staples. In this context, we remain over-weight US equities. In spite of the current volatility, we maintain a constructive view on healthcare, technology, global e-commerce and financial services.

On the fixed income side, yields on global sovereign debt are now so low they barely qualify as "yields" anymore. Both France and Portugal saw their ten-year bond yields fall to zero. Parenthetically, Portugal’s 10-year yielded 16.5% in 2012. Germany saw its 10-year yield plunge to -0.3%, Japan's 10-year dropped to -0.15%. Sweden and Austria’s 10-year also turned negative.  The US 10-year Treasury is testing 2.0%—which towers above other government yields. There's now $12.5 trillion worth of negative-yielding debt globally.  All of this is obviously manna for equity prices since investors have no other attractive major asset class to allocate their funds to. The problem is so familiar it has its own acronym: TINA, or There Is No Alternative to stocks. With 10-year Treasury yields at 2% and futures priced for at least two U.S. rate cuts this year, where else can you go but stocks?

On the surface, the bond market and the stock market are telling us divergent stories but somehow global investors have found a way to reconcile conflicting signals. The US bond market is signaling an economic slowdown. The US stock market, now back at a record high, is suggesting growth will continue. When taken together, the only way these seemingly incongruous stories can make sense is if we conclude that the bond market is in fact telling us that the Fed’s fear of an economic slowdown will push it into aggressive preemptive action. Stocks, meanwhile, are telling us that the Fed will continue to do what is necessary to prevent a slowdown, as it has done successfully since the financial crisis. However one spins this scenario, it is apparent that investors are submitting to this seductive narrative.

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The End of History?….. The bull market is now in its tenth year, the longest in the S&P’s nearly century history.  Twice the length of the average bull market, stocks have more than quintupled since 2009. With each passing month, speculation increases as to the prospective end of this historic run.  In this regard, the deluge of market information we receive every day may be correlated with increasing levels of market uncertainty. We are inundated with new information and opinion from all quarters. Rather than join the bloviating pundits as to when equities will cease their relentless rise, suffice it to say that there is little comparability in the history of key inflection points that trigger major turning points in the market cycle.

Major market cycles, for both stocks and bonds, can last for extended periods of time. However, what remains salient for most investors are the market defining themes of their particular investing generation:  collective experiences that they lived through and repeat unconsciously in their minds. Subsequent market action are then filtered through this cognitive lens, often with only minor variations.  During the last decade, the current cohort of younger investors have not yet undergone the existential panic of losing a large percentage of their net worth. Consequently, they do not bear the scars of previous generations who staggered through the 1970s “end of equities” era, the 2000-2001 Internet bubble catastrophe, or most recently, the Great Recession of 2008.  Fortunately, for the time being there is a distinct absence of market euphoria and investor complacency that often suggest market tops.

Would it be too pollyannish to imply that investors might actually learn from the bitter experiences of their predecessors? Noch einmal, I pose the question that I presented in my 2001 book Paradigm Lost:  “Are we riding the arc of a rising curve leading us further out into the Digital Age?  Or is the wheel about to arrive full circle yet once again?”

As at the outset of this year, we reiterate our preference for defensiveness, lower relative volatility and incrementalism. Although economic conditions are still sanguine, we continue to seek greater resilience in our portfolios.  This means favoring U.S. large-cap quality companies with robust profit trends, high dividend yields and low debt levels.   We also tilt toward international diversification since foreign stocks on average have lower valuations and higher dividend payouts. Finally we continue to maintain above-average cash reserves to increase our short-term flexibility.  Whether the stock market future repeats or merely rhymes, we intend to be there, at the ready.

"You will never be happy if you continue to search for what happiness consists of.
You will never live if you are looking for the meaning of life."
 -Albert Camus
 

Strange Days (When You’re a Stranger).…. In Q1 2019, the S&P gained 13.1%, its best quarterly performance since 2009.  This sparkling increase immediately follows a debilitating Q4 2018 that was tantamount to a 20% bear market debacle. The YTD gains have all but reversed the market slide of the preceding quarter. Did the world change that much in the course of three months, or were we once again subjected to the bipolar vacillations of Mr. Market? In Q1 at least, it seems that the manic FOMO Syndrome (“fear of missing out”) trumped the depressive fear of impending recession!

The stock rally occurred in spite of aroused fears of a weaker economy and an inverted yield curve that typically is predictive of a recession.  The 10-Year Treasury note’s yield fell a stunning 28 basis point during the quarter, reflecting the Fed’s shift away from further interest rate hikes for 2019.  So far, YTD market action has been vexingly counter-intuitive:  bond yields are falling because of a weakening economy, but lower rates and the Fed’s more dovish stance has injected the equity markets with a renewed sense of optimism.  This has been most evident in the NASDAQ rising by 16.5% in Q1 as Big Tech (+19.4%) is less dependent on overall economic growth.  Low bond yields have also been a boon for dividend paying stocks as well. For Q1, REITs were +16.6% and utilities +9.9%.

Meanwhile, international investors also joined the party, as the MSCI World Index, EAFE and the Emerging Markets Index rose by 11.9%, 9.0% and 9.6% respectively. With increasing confidence that a US-China trade deal is imminent, the Shanghai Composite spurted ahead by 23.9%. The high yield bond sector continued its robust performance, returning 7.6% in Q1. Likewise for commodities, led by a rebound in oil prices, rising by 8.6%.

Investors remain obsessed with the trade war between the US and China, as well as a looming recession. The American economic engine certainly seems to be slowing even as the eurozone and emerging markets continue to cool off.  In 2019, we believe the key to both the US and international equities is China, resting on a reasonable resolution of the trade wars.   We expect China to maintain its controlled expansion. Q1 corporate earnings reports will also affect investor sentiment. Our market agnosticism notwithstanding, there is still a case for cautious optimism.  Historically, it is unusual for US equity markets to decline two years in a row.   The key issue for investors now is to be aggressive or defensive?  An expensively valued stock market, coupled with weakening economic fundamentals, warrants caution.  Accordingly, we still lean towards increased exposure to defensive sectors such as utilities, REITs and consumer staples.  In this context, we remain over-weight US equities.  In spite of the current volatility, we maintain a constructive view on healthcare, technology, global e-commerce and financial services.

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The Virtue of Self-Interest….. As active investors engaged in the daily tribulations of the securities markets, it is easy to overlook the philosophical and spiritual underpinnings of our chosen profession.  Twenty years ago, I published my first book entitled The Mind of the Market wherein I argued for a more nuanced understanding of a free auction market economy.

In the famous parable of the ethical versus the enterprising shopkeeper, a shopkeeper who manages his affairs efficiently, and charges all his customers the same competitive price for the same goods, maintains both his customers and his profits.  His positive reputation serves to secure his own material interest, prosperity and happiness.  In this manner, self-interest (or the pursuit of private happiness) has resulted in a just outcome.

Since that time, we operate in a system where the “butcher, the baker and the candlestick maker” can each pursue his own self-interest in a way that is not only self-stabilizing, but also can promote behavior profitable to the broader economy.  Adam Smith was the most articulate proponent of how such a market economy drives a “moral economy.”  As a counterpoint to the Kantian notion of an absolute moral law, Smith made a compelling case for how market economics - and the self-interested behavior it requires - encourages both private satisfaction and public liberty.  Moreover, he seductively metonymized the phrase “free market capitalism” to capture our most ennobling desires.

However, self-interest goes beyond simple material gain.  It also has the capacity to encompass a broader notion of the “pursuit of happiness” that is more than mere remorseless competition or the dead-end of a hedonic treadmill.  In a subsequent book entitled Wealth and Responsibility, I set forth a new paradigm wherein the pursuit of wealth is based upon a more viable economics of happiness.  An enlightened calibration of the concept of self-interest allows us to pursue not only profit and pleasure, but also to move in the direction of fulfilling our individual desires.  Viewed in this context, the ethic of self-interest encourages us to ultimately determine for ourselves what happiness really consists of.  

I am an optimist; it does not seem much use to be anything else.
 -Winston Churchill   
 

The Winter of Our Discontent….. The pundits are dubbing the current market debacle as the “zombie market,” wherein investors stumble around in a daze, reacting haphazardly to the latest news or sentiment of the day or even the hour.  Since the S&P 500 hit an interim high on Sept. 20, the US equity indices has lurched backwards by 20%, the standard definition of a bear market.  Pointedly, the Dow had its worst December since 1931!  And the overall market experienced its worst year since the 2008 Great Recession.

The hyper-volatile day-to-day moves reflect investors’ growing unease at the prospect of an impending recession.  Only three months ago, the market seemed to be pricing in a strong economy.  But by the end of Q3, the first signs of an economic slowdown began to emerge. The S&P fell 14% in Q4 and ended 2018 with a loss of -6.25%, with the Dow and NASDAQ following similar trajectories.

As rough as the US domestic market has been, it was far worse for international investors.  The Emerging Markets Index declined by approximately 20%, dragged down by China’s Shanghai Composite -25% collapse. Meanwhile, the EAFE fell 16.1%, and the World ex-US index was down 17.1%.  Except for the safety of cash, Treasuries and the muni market, there was no place to hide. Even corporate bonds (including high yield) declined on average by 2.5%.  Likewise for commodities which fell by 8.1%.

Investors are now obsessed with the escalating trade war between the US and China, as well as a looming recession caused by the Federal Reserve’s interest rate hikes. In the midst of chaotic political uncertainties and divisive culture wars, the American economic engine may be slowing even as the eurozone and emerging markets continue to cool off. There are plenty of risks: decelerating U.S. economic growth, a fallout in technology stocks, rising interest rates and - last but not least - trade wars and government shutdowns. There are also troubles aplenty overseas: European economic growth has stalled; in Latin America there is political crisis in Brazil, Argentina and Venezuela;  China stocks have been in a bear market all year; and the Turkey debacle has cast a pall on emerging market debt and equities.

On the fixed income side, with further interest rate hikes expected in 2019, headwinds will continue for bond investors. The only positive news for investors is that, for a first time in a decade, savers can look forward to some modest income from their cash holdings.  This provides a little bit of solace for investors who are too risk-averse to be in the equities markets.

In 2019, the key to emerging market equities is China.  Although the Middle Kingdom is beset with structural problems, we expect China to maintain its controlled expansion.   In this context, we remain over-weight US equities.  On the fixed income front, we have virtually no exposure, given our negative assessment of the current risk/reward for bonds.  Finally, in spite of the current volatility, we maintain a constructive view on healthcare, information technology, global e-commerce and financial services.

All of the above headwinds notwithstanding, there is still a case for cautious optimism.   Thanks to the end-of-year selloff, tremendous value can now be found in the markets. Historically, it is unusual for US equity markets to decline two years in a row. The key to investment success in 2019 is to focus on investments that have business models capable of weathering increases in inflation, worsening trade relations with China, and balance sheets capable of handling rising interest rates. Finally, new positions must be acquired at a significant discount to fair value in order to render a sufficient margin of safety. Admittedly, this is an exercise in considerable subjectivity (more on this in the last paragraph below).

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The Beginning of the End (of the bull market), or the End of the Beginning (of a cyclical pullback)?….. In the everyday world we live in, events and sentiments typically change incrementally, with a causal linkage that is not too difficult to discern.  However, in the world of investing, the psychology of the market is often so irrational and extreme, that it more closely resembles the bi-polar psyche of the borderline patient.  Nobody really can explain why this happens or can reliably predict what the catalyst is that compels stock prices to swing from the euphoria of “priced for perfection” to the despair of “total capitulation.”

The dramatic market sell-off in Q4 2018 could be the start of a bear market, or just another rough patch in the vicissitudes of market cycles.  One can scarcely divine its meaning while it is happening, and only in retrospect, can its longer term import become intelligible.  With little rhyme or reason, the market selects certain issues to obsess over on the positive side (e.g. earnings growth, low unemployment rates, low absolute rates); then it shifts its focus onto other items on the negative side (e.g. trade wars, flat yield curve, P/E ratios, etc.).    That’s why it is such folly to attach much meaning to short-term fluctuations.

The key issue for investors now is to assess whether it is time to be aggressive or defensive.  Managing risk and accurately assessing where the market cycle is at - within the context of a 3-to-5 year time frame - is the determinative decision for portfolio managers.  Are most investors obsessing over the negatives over the positives, or vice versa?  Right now, after a long bull run, it is prudent to be defensive, to hold an above-average level of cash, and to avoid leverage.  Minimize portfolio losses during market pull-backs, and have cash ready to invest when it is easier to make money.

The sober reality is that consistently making money in the markets is an intensely competitive undertaking.  Every marketplace dynamic conspires to drive us to extremes:  to buy when prices are going up and to sell when prices are dropping.  It is only investor discipline and controlled emotions, combined with an informed market intelligence that helps us resist these wealth-destructive temptations. 

I know it's only money, but I like it, like it, yes I do.
 -Mick Jagger, Keith Richards, "It's Only Rock 'n Roll (But I Like It)" 
 

Neither Calm Nor Exuberance….. In Q3, U.S. equity markets widened their lead among global asset classes, dramatically outperforming other international and asset category indices. While the MSCI World and EAFE have generally moved sideways for much of 2018, the S&P 500, Dow and NASDAQ have powered ahead with YTD gains of 9%, 7% and 16%, respectively. In fact, U.S. stocks enjoyed their best quarter since late 2013.

Oddly enough, there is little excitement or fanfare on the part of most professional money managers.  With this latest move up, U.S. equities are now trading at their highest premium to international stocks in many years, reflecting investors’ sentiment that the domestic economy and the strong U.S. dollar will continue to outpace the rest of the world.  In the midst of chaotic political uncertainties and divisive culture wars, the American economic engine has maintained its growth trajectory even as the eurozone and emerging markets have cooled off.  The result is that U.S. equities, on a price/earnings basis, are now valued at a 12% premium to overseas markets. reflecting its consensus safe-haven status. Relative to the U.S., the valuation discount for emerging market stocks is now around 30%

Is this divergence sustainable?  Most likely not, but when it ends nobody knows!  There are plenty of risks:  decelerating U.S. economic growth, a fallout in technology stocks, rising interest rates and - last but not least - trade wars and political upheaval.  But for now, the U.S. is leading the rest of world, not just economically but in terms of corporate innovation and entrepreneurship.  This explains why investors are willing to pay a premium for expensive U.S. stocks while avoiding emerging market assets.

Importantly, although the MSCI World Index gained 3.9% YTD, ex-U.S. that gain converts to a -5.2% loss YTD.  There are troubles aplenty overseas: European economic growth has stalled; in Latin America there is political crisis in Brazil, Argentina and Venezuela;  China stocks are in a bear market; and the recent Turkey debacle has cast a pall on emerging market debt and equities.

On the fixed income side, virtually all asset classes are showing YTD losses except the high yield sector which is steadfastly up by 2.5% YTD.  With further interest rate hikes in the ensuing quarters, headwinds will continue for bond investors.  Outside of American stocks, the only other somewhat positive news for investors is that, for a first time in a decade, savers can look forward to some modest income from their cash holdings.  This provides a little bit of solace for investors who are still too risk-averse to play in the equities markets.

For the balance of 2018, the U.S. economy is still solid and showing growth, even as inflation is rising. With the global markets entering a tougher environment, investors have lowered their expectations. The stock’s market capacity to absorb these negative headwinds is now in question. Our overweight position in global equities relative to bonds delivered positive performance.   Due to the strong relative performance of the U.S. equity markets, diversifying our risk across   regions rather than remaining exclusively US-centric has lowered our absolute performance YTD.

Nonetheless, global growth looks to be robust enough to provide support for stocks.  The key to emerging market equities is China.  Although the Middle Kingdom is beset with structural problems, we expect China to maintain its controlled expansion.   In this context, we remain over-weight US equities.  On the fixed income front, we remain strongly under-weight in a mostly dismal year for bonds.  Our long standing positions in high yield bonds and high dividend-paying equities provide both current income and capital appreciation, while muting stock market volatility.  We continue to be bullish on healthcare, information technology, global e-commerce and financial services.

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Thoreau’s Clarion Call:  “Simplify, simplify”….. In my most recent musings, I suggested  “less is more” as an inspiration to move towards minimalism, a balm to soothe hectic, stressful modern lives.  In Thoreau’s literary classic Walden, he laments the tawdry excesses of American prosperity.  He suggests that the pecuniary impulse can overwhelm the human spirit, and that we become ever more dependent on others to protect our comfort and wealth.

The practical implication is that each of us must make choices and assign particular importance to one kind of information, asset or activity relative to others.  In Thoreau’s celebration of radical individuality, we learn the limits of our own choices, the moral imperative of asserting our own values, and ultimately, to dream the desire of fulfilling them.

In his mordantly lacerating prose, he chipped away at Americans’ faith in technology, their proclivity to mass distraction,  and their mindless materialism.   In Zen-like serenity, he declared that the goal of life is to “inhabit the nick of time” - referring to precisely the present moment where the past and the future converges.  From being both mindful and present, thus emerges one of Thoreau’s most trenchant insights:  that to know one thing exhaustively is to glimpse the cosmos.

As someone who has spent a large part of a working lifetime in the investing business, I find immense value in trying to remain impassive and objective in what is often a confounding, emotion-laden and unpredictable environment.  Sometimes in the midst of market tumult, I compensate by reminding myself just to “simplify, simplify.”  In a nod to one of the ironies of modern life, the author Erica Jong quipped:  “Bankers talk about meditation, writers talk about money.  Spirituality is expensive.”  And so, whether it be exhilarating gains or numbing losses, I know it’s only money, but I like it, like it, yes I do.

He who wants less, ends up with a sense of having more.
 -Zen and the Art of Investment Management
 

Any Port in a Storm?….. If 2017 trading markets were marked by strong, low-volatility returns, the first half of 2018 has been all about risk.  The risk premium has been repriced upwards to reflect escalating trade wars, renewed geopolitical tensions, and a more vigilant central-bank monetary policy.  As a result, investors have been quick to pull the sell trigger and much more cautious about what can go wrong.  This inevitably results in exaggerated reactions to short-term events, forcing investors to be much more nimble and tolerant of week-to-week fluctuations.  This year’s modest YTD gains have been hard won.

For Q2, the S&P 500 squeezed out an anxiety-ladened 2.9% gain (1,68% YTD) while the DJIA fell back by a similar amount.  Only the technology-laden NASDAQ, led by the inexorable FAANG cohort, was able to power ahead and is now up by 8.8% YTD.  Overseas, the EAFE index continued to struggle and is now down by -4.5% YTD. The US dollar index has rallied 3.3% this year and 7.4% since its February low. The surging dollar, coupled with political and economic uncertainties in the Eurozone, economic chaos in Brazil, Argentina and Venezuela, and threats of global tariffs everywhere have all exerted downward pressure on both emerging market equities and bonds. Emerging markets tumbled in the second quarter after a stronger dollar and higher U.S. interest rates led many investors to flee from riskier investments in the developing world. The MSCI Emerging Markets stock index fell 8.5% in Q2, the index’s worst quarterly performance since the third quarter of 2015. Emerging-markets bonds lost 3.6%. Ominously, Chinese equities entered into a bear market, with the Shanghai Composite down 13.9% YTD.

However, the global economy is still solid and showing growth, even as inflation is rising.  In the US, corporate tax cuts have boosted profits.  Offsetting this is the strengthening of the US dollar that is slowing demand growth at US multinationals' overseas operations, while concurrently trimming the profitability of non-US companies. With the global markets entering a tougher environment, investors have lowered their expectations, such that the S&P 500 now trades at about 16x expected earnings versus 18.2x at the start of the year.  The stock’s market capacity to absorb these negative headwinds is now in question.

Our overweight position in global equities relative to bonds delivered positive performance. Despite a bumpy first half, global stocks have returned about 1%. Global corporate earnings growth (9% in H1) has been strong enough to support global equities,  even as higher interest rates weighed on bond prices.  Diversifying our risk across markets resulted in a smoother ride than remaining exclusively US-centric. For example, global equities suffered just two days of greater than 2% declines vs. eight days for US stocks, six days for Chinese equities, and 17 days for Brazilian shares.  Overall, with modestly positive equity performance and negative bond performance, moderate-risk balanced portfolios are broadly unchanged YTD.

In recent months, Italian elections, turmoil in Turkey, Brazil and Argentina, and renewed fears about protectionism have kept uncertainty high. As we look ahead to H2, volatility is likely to continue. Even if some individual political concerns fade, central banks are withdrawing liquidity from markets, slowly removing a major suppressant of volatility in recent years.

Nonetheless, global growth looks to be robust enough to provide support for stocks. A strong US labor market should underpin consumption and drive business investment. Eurozone growth has moderated, but we believe it remains solid. We expect China to maintain its controlled expansion. And with global earnings growth (9%) outpacing this year’s equity market returns (1%), valuations have improved at the margin.  Investors will need to prepare for this environment by staying invested to benefit from economic growth, but also diversifying globally.

In this context, we are over-weight US equities, but have pared back our allocation to technology names, given their strong appreciation in 2017. On the fixed income front, we remain strongly under-weight. In a mostly dismal year for bonds so far , investors are finding the best returns in high yield corporate debt. The High Yield Index posted a YTD positive return of 0.1% versus a 3.3% drop for investment grade corporate debt, a 2.7% decline for 10-Year Treasuries, a 0.3 % slippage in munis, and 3.6% fall in emerging market debt.  Our long standing positions in high yield bonds and high dividend-paying equities provide both current income and capital appreciation, while muting stock market volatility.  We continue to be bullish on healthcare, information technology, global e-commerce and financial services.

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When “Less is More?”….. Recently I had occasion to ponder this truism as I helped a good friend relocate.  A former shopkeeper and an inveterate shopper, she had accumulated a prodigious amount of things spanning various categories, including clothing, housewares, decorative accessories and sundry antique collectibles.  Some of these things were meant for an eventual profitable resale, but many possessions were acquired in the heat of an impulsive moment and a cheap price.

As the deadline for the move drew ever closer, she had a difficult time reconciling the fact that she had very limited space to store her possessions and that reselling personal items is inevitably a slow and cumbersome process.  The many acquisitions  she had previously invested with such interest and excitement had become an unmanageable and tiresome burden.  Without the space to store her excess material possessions nor the time or energy to carefully curate their optimum disposition, she was forced to either sell these once prized items in a fire sale, give them away to friends or simply send them to the dumpster.  All of these options were  disconcerting, as these default scenarios were experienced as frustrating or dissatisfying.

I viewed her situation as a parable of other realms in our lives, either in the context of our material possessions, our social constellations, our daily behavioral routines or our emotional investments.  In each case,  the cumulative iterations we go through to  - acquire more things, make new acquaintances, accelerate our busyness, or assume incremental emotional commitments - all ineluctably  take a toll on us.  Do they enhance our lives, or do they insidiously deplete our spirit?  When we want or pursue too much, do we lose our focus, do we fall prey to the illusion that “more” brings more satisfaction, more meaning?  Or do we succumb to complacency, distraction,  mindlessness and sheer exhaustion?

There is a simple lesson here for profitable, long-term investing. Anyone with significant assets must note that investing cannot be a passive activity.   Either directly or via a trusted financial advisor, investing is a serious business.  For the active investor, act with a clear focus and objective, limit the number of discrete investments to a manageable level and make sure you understand the thesis for each position.  Once a portfolio has been established, monitor it carefully and make adjustments as appropriate.  The markets can change at a startling pace and it is necessary to both accommodate and anticipate these changes.

As Bertrand Russell slyly observed: “To be without some of the things you want is an indispensable part of happiness.” 

He not busy being born is busy dying..
 -Bob Dylan

Da Capo (Once More! Once More!).…. After three years of relative calm, volatility returned with a vengeance.  For Q1 2018, the S&P fell 1.2%, breaking a string of nine quarterly gains, and more importantly, snapped positive investor sentiment as well.  The dramatic return of volatility, somewhat mitigated by investors’ habit of buying on market dips, allowed the major equity indices to post only modest losses. The MSCI World Index, EAFE and Dow all fell back  approximately 2%. Only the Nasdaq was able to squeeze out a 2.3% gain, although many prominent technology names endured the bear’s mauling as well.  The net result for Q1 was troubling but not devastating.  Moreover, the recent market tumult placed a spotlight back on individual stock-picking rather than a passive reliance on the market indices.

The roller-coaster ride commenced in January when stocks hit repeated highs, with the S&P gaining 7% in the first three weeks alone.  Many investors were already smugly sitting on nearly a year’s worth of gains in less than one month, until the rude intervention of market reality asserted itself in February.  The VIX (CBOE Volatility Index or the “fear index”) posted its largest-ever one day increase from the high single-digits to nearly a four-fold increase (it closed the first-quarter at 19.97, surging about 80% for Q1). This dramatic spike triggered a  decline in the major indices of more than 10% over nine trading sessions.  It’s All Right, Ma (I’m Only Bleeding).

The VIX spike shattered the market tranquility of 2017 and sent the Dow and S&P into its first correction in two years.  On the fixed income side, the 10-Year Treasury yield hit a four-year high, thus exacerbating the market panic.  Then in March, major technology stocks gave back  their recent gains as fears of greater regulation and slowing growth pricked the burgeoning tech bubble. Pundits quipped that technology investors got FAANGed, as the dominant technology cohort of Facebook, Apple, Amazon, Netflix and Google shed about $400 billion of market value  since the recent NASDAQ peak in January. Shaken out of their collective, complacent optimism,  ebullient tech investors were rendered eyes wide shut!

As expected,  the Fed raised interest rates in Q1 and likely will do so again at least 2-3 times more in 2018. Various geopolitical shocks such as trade wars and threatened regulations. as well as natural catastrophes, continue to weigh on the market although their immediate impact often   remain unpredictable. In the usual market tautology, Mr. Market, in his perpetual fecklessness and moodiness, blithely dismisses these distractions until he doesn’t.  That notwithstanding, American businesses continue its resurgence, and the economies of many countries around the world remain on a course of recovery. What really changed in Q1 was a more skeptical investor sentiment regarding the sustainability of fundamental economic expansion, particularly in China and Western Europe.

In this context, we remain equal-weight in U.S. equities, but have somewhat pared back our allocation to technology names, given their strong appreciation in 2017. On the fixed income front, we remain strongly under-weight. Our long standing positions in high yield bonds and high dividend-paying equities provide both current income and capital appreciation, while muting stock market volatility.  We continue to be bullish on healthcare, information technology and financial services.

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How Not to Get Rich….. The field of behavioral finance was established to identify irrationalities in investor behavior and thus prevent people from doing stupid things with their money.  Yet the systematic application of mathematics and psychology to economics, despite all its brilliant and fascinating revelations, have failed to arbitrage away market inefficiencies.  Among numerous examples, why do stocks do well in the month of January (as it did again in 2018)?  Why does the old nonsensical Wall Street cliche “Sell in May and go away”  still retain faithful believers?   Why do almost all investors “overreact” to unexpected or dramatic news events, driving valuations to extremes?   Why do we loath taking losses so much more than gains?  Such insights are important to investors but they do not seem to really change their behavior.

Study after study confirm how poorly most investors  understand money and investing.  Even if they exhibit some degree of financial literacy, they often fail to understand why they invest the way they do, and what their behavior means for their current and future well-being.  Ironically, this kind of ignorance can be even more damaging than merely not knowing financial facts.  Professional investing, unlike most other professions such as surgery or engineering, does not follow a cumulative set of formulas or data points.  An investor may not increase his rate of success by trading more frequently or over a longer period of time.

Trading markets and their underlying asset values are predicated on two wildly complex  dynamics:  the constant, rapid assimilation of new information, and the gyrating passions of human nature. Benjamin Graham, the father of modern investing, famously said that “Wall Street people learn nothing and forget everything.”  In a similar vein, this author has suggested that “the history of the stock market is the history of forgetting.”

This Nietzschean “eternal return of the same” is crucial to understanding investment performance because the so-called market is not a stable entity, nor is there a “true active investor” to be discovered.  Rather, the market and the investor are constantly becoming.  To paraphrase Nietzsche’s exhortation to “become who you are”, we shed our old bark, we shed our skins with every new investment season.  It is a continuous act of re-definition.  

Money is the complex over which,  for reasons that go back to my childhood,
I have the least control.
 -Freud

Give Me Love (Give Me Peace On Earth).…. Aaah, 2017 is over! What more can a professional investor ask for? The S&P rose 19% while the Dow and NASDAQ gained 25% and 28%, respectively.  Even more delightful, the S&P did not suffer a single month of negative returns, an unprecedented achievement that highlights the blissful dead calm in market volatility. So let us savor this ephemeral moment of satisfaction, even as we anticipate what fateful tidings awaits us in 2018.

Of course, not every market segment participated in the celebrations:  the US dollar declined by 7.5%, the Fed raised interest rates several times in 2017 and will do so again in 2018, and all manners of geopolitical and natural catastrophes inundated our screens.  But the market blithely dismissed all those distractions because none of them hurt corporate profits.  Just as importantly, while American businesses continued its resurgence, the economies of many countries around the world started an accelerated recovery.  The cumulative result was a global synchronized growth that buoyed investor sentiment throughout the year. What is accounting for these benign circumstances are fundamental economic expansion in nearly every major region; and this has allowed investors to remain sanguine about the doom-and-gloom scenarios of market skeptics. The real question is what might force investors to change course and not pay 18x forward earnings for the S&P 500?

On the international front, the eurozone is more optimistic about its economic prospects than any time in the past decade, with the EAFE turning in a +21.8% in 2017.  In the Asia Pacific region, the Hang Seng returned 36%, the Nikkei 19% and the Indian Sensex climbed 28%, all spurred on by solid earnings and positive investor risk sentiment.  Although equity prices rose dramatically in 2017, there are still sectors that are attractively valued.  For example, Asian equities currently trade for only 13x forward earnings.  There is still massive liquidity in the markets and the global economy, including China,  remains in a stimulus phase. Absent a decisive shift to the negative or a massive exogenous shock, there is still  room on the upside for 2018.  Equities are expensive but, compared to bonds and cash, remain the best available asset category.

We are equal-weight in U.S. equities, and have increased our allocation to technology names in H2 2017. On the fixed income front, we remain strongly under-weight bonds, with the exception of  the high yield sector which had a total return of 7.4% in 2017. Our long standing positions in high yield bonds and high dividend-paying equities provide both current income and capital appreciation, while muting stock market volatility.  We remain bullish on healthcare, information technology and financial services, especially those companies whose strategic positions are best leveraged towards the burgeoning global e-commerce space.

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Buddy, can you spare a Bitcoin…..? 2017 was clearly the Year of the Bitcoin.  Since 2009, Bitcoin has increased in value from 39 cents to briefly approaching $20,000.  In 2017 alone, this digital currency has increased its market value by by roughly 15-fold.  Is Bitcoin a bubble, a mania, and just the latest example of human financial folly that, from time to time, has afflicted gullible, greedy investors  since the days of the Dutch tulip mania?  The answer to this question is already being feverishly debated by experts, neophytes and all sorts of interested observers inexorably sucked into a spectacle that’s simply too riveting and engaging to ignore.  Like the party next door that’s so loud and prurient to dismiss, much ink has already been spilled on this subject; so this commentary will refrain from opining on the ultimate financial value of  Bitcoin or any other crypto-currencies.

Instead, what is more telling about the rise of digital currencies is that it once again confirms the essential nature of the “animal spirits” that Keynes ascribed to the dynamism and excitement of free auction markets.  Analogous to the two most recent financial debacles of this still young century - namely, the Internet in 2000 and the saturnalia of financial over-engineering in 2008 - one can get another front-row seat in the psychodrama of watching Wall Street people learn nothing and forget everything.

Yet there may be another, more compelling reason to think that something more fundamental is happening.  In a trend that transcends finance, crypto-currencies may be signaling an accelerating transfer of social and financial capital away from governmental institutions to systems not reliant on human error or corruption.  In our growing mistrust of governments, indeed of any other human institutions tainted by incompetence or malfeasance,  we are developing a new faith in pure technology.  As in many other realms of everyday life, we are learning to rely on well-tested computer code to transport us, identify our whereabouts, and aid in many other daily tasks.

Bitcoin both reflects and advances this trend.  It was born in 2009, inspired by the human carnival of unbridled greed and suspension of reason that plunged the financial system of advanced economies into near collapse.  Banks around the world, heretofore paragons of financial trustworthiness (in collusion with so-called sophisticated investors), revealed themselves to be reckless stewards of comically complex assets backed by an indecipherable web of promises.  Meanwhile, paper currencies, once backed by the gold standard - now only by the credit of governments - are increasingly perceived as feckless and unpredictable.  Perhaps global investors are just seeking some alternatives?

As an asset class independent of governments, banks or other private institutions, Bitcoin is based on a blockchain technology that creates a decentralized public ledger methodically tracking transfers of ownership.  Unlike stocks or bonds, one might argue that Bitcoin gives the owner a claim to nothing more than Bitcoin itself, and therefore a heuristic that is as illusory as it is risible.  Yet that asset is really no more illusory than paper currency or stock certificates, since both assets arguably represent a class of shared hallucinations that derive value simply because enough others value it sufficiently. To press the analogy, is a private computer code any less or more valuable than a digital entry in a bank or broker’s computer file?

Undoubtedly, despite its virtual nature, Bitcoin will soon confront its own set of human fallacies and governance issues.  The pundits will continue to debate whether it is a bubble or an important new asset class, but what it highlights is the eternal question of what and with whom shall we place our trust in?   

Ideas are easy; it's execution that's hard.
 -Jeff Bezos, Amazon.com  

The Tormented Bull….. The S&P 500 finished Q3 at a record, up +12.5%, supported by strong corporate earnings and upbeat economic data.  The major equity indices continued their steady ascent, with trading remaining calm even in the face of periodic geopolitical tensions and natural catastrophes.  Even as the equity markets grind higher, trading volatility is experiencing multi-decade lows. What is accounting for these benign circumstances are fundamental economic expansion in nearly every major region; and this has allowed investors to remain sanguine about the doom-and-gloom scenarios of market skeptics.

On the international front, the eurozone is more optimistic about its economic prospects than any time in the past decade, with the EAFE turning in a +17.2% return thus far in 2017.  In the Asia Pacific region, the Shanghai Composite, Hang Seng and the Nikkei all posted their best quarterly performances in recent years, spurred on by solid earnings and positive investor risk sentiment.  There is massive liquidity in the markets and the global economy is still in a stimulus phase.

Year-to-date, the MSCI World index is up +14.2%, led by stalwarts such as Hong Kong (+25.2%), India (+17.%%) and South Korea (+18.2).

This long, extended bull market continues to bear an inordinate amount of doubt and skepticism, yet there is little of the investor euphoria that is associated with market tops.  Investor sentiment is decidedly cautious to neutral and that, ironically is good for stocks. At 19x current year’s earnings, the S&P 500 is indeed fully valued, but high valuations alone do not trigger a bear market.  Even the Fed signaling moderately rising rates does not necessarily mean equities will drop.  Absent a decisive shift to the negative or an external shock, there may still be room on the upside for the balance of 2017.  Equities are expensive but, for now, remain the best available asset category.

We are now equal-weight in U.S. equities, having increased our allocation to emerging market positions. On the fixed income front, we are strongly under-weight bonds, with the exemption of  the high yield sector which has confounded its critics over the past five years. Our long standing positions in high yield bonds and high dividend-paying equities continue to provide both current income and capital appreciation, while muting stock market volatility.  We remain bullish on healthcare, information technology and financial services, especially those companies whose strategic positions are best leveraged towards the burgeoning global e-commerce space.

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Radical Truth, Radical Transparency….. or Megalomaniacal Narcissism? An eternal truth in our besotted, money culture is how we unceasingly valorize those individuals who are able to achieve conspicuous levels of wealth.  A case in point:  the recent publication of Ray Dalio’s tome Principles.  As most professional investors know, Dalio is the founder of Bridgewater Associates, the world’s largest hedge fund.  The precepts that he espouses in this book underlie how he runs his firm and purportedly explain how he has been able to achieve nearly $50 billion of profits for his investors.

At the outset, Dalio wanders into the realm of both metaphysics and psychoanalysis when he poses these two central questions:  1) what is true? and 2) what do you want?  When the author asserts that “you can never be sure of anything,” he is merely echoing the sentiments of philosophers dating from Socrates to Bertrand Russell to the legendary investor George Soros. Soros was much more poetic when he confessed that he was “an insecurity analyst” because he was always cognizant that he might be wrong and therefore started from a position of insecurity.  In comparison, Dalio does not seem to have suffered from any bouts of insecurity, much less humility.

In Dalio’s second basic question “what do you want?”, he is really posing a psychoanalytic yearning.  This is because the root of psychoanalysis is desire.  By desire, I am referring to the distinctly human urge to seek meaning and satisfaction in our life.  Essentially, desire is a human being’s unfulfilled need, be it physical, sexual, emotional, spiritual or financial.  In desire, we are searching for both missing, disowned pieces of ourselves and for something beyond ourselves, outside the borders of self-recognition.  As Lacan has articulated for us, in analysis is where the analysand discovers, in its most naked and austere form, the truth of his or her desire.   This is a journey in which science, philosophy, religion and least of all, psychiatry have all shown themselves to be woefully insufficient.

So how does Dalio connect his idiosyncratic precepts to the day-to-day realities of investing and managing a hedge fund?  In essence, an “idea meritocracy” - wherein the best ideas win out and meaningful relationships are created - are facilitated by the promotion of radical truth and radical transparency.  According to Dalio, we need radical truth because investors have chronic difficulty in comprehending reality, afflicted by the many blind spots that prevents us from seeing the truth.  Therefore, the antidote is regular doses of humility and questioning that forces us to embrace change and to remain open-minded.  In Dalio’s Orwellian world view, individuals are machines operating in a complex, interactive system, increasingly commoditized by the ongoing digital revolution.  In practice, this means that Bridgewater employees are subject to continuous monitoring, intrusive scrutiny and often public criticism, akin to the self-criticism rituals of Mao’s Cultural Revolution.  Instead of facilitating harmony and open-mindedness, this  management style is more likely to be experienced as dehumanizing and dangerously reductive.  In fact, his lieutenants have told him in writing that his management style make his employees feel “incompetent, unnecessary, humiliated, overwhelmed, belittled, oppressed or otherwise bad.” Predictably, the employees that choose to work in this cult environment are seduced by the siren song of filthy lucre.  Although one cannot argue with Bridgewater’s success, there is no evidence that its remarkable financial results are solely attributable to the authoritarian and megalomaniacal speculations of its founder.

Although the author repeatedly extols the virtues of humility and simplicity, what Dalio actually offers in this ponderous, sizable  567-page book is - in the words of one critic - “a vast, clanking engine of tenets” - that is, in turn,  inconsistent, pretentious and sometimes just plain bizarre. Would you want to be pigeonholed by the required application of the questionable Myers-Briggs personality test, publicly ranked in a firm-wide “believability” rating, or otherwise have your every move systematically recorded?  Thanks but I will pass! If not for the simple fact that this work is a memoir and confessional of a prominent member of the investment world,  one may be excused  for avoiding this monumental claptrap to narcissistic self-indulgence.  

I'm very big on having clarified principles. I don't believe in being reactive.
You can't do that in the markets effectively.
 -Ray Dalio, Bridgewater Associates  

Keep Your Motor Running, Head Out On the Highway…..

The S&P 500 posted its strongest H1 since 2013, climbing +8.2% and setting new highs. Similarly, the NASDAQ climbed +14%, propelled by a handful of major technology names and setting 38 closing records, with the best first-half since 1986. Investor optimism reflected solid corporate earnings and expectations of continuing economic growth in 2017.

However, there are storm clouds on the horizon. The world’s central banks are all leaning towards rate hikes and the end of the easy money that has fueled an 8-year bull market.  Quantitative easing is already  in the rear view mirror, and an increase in volatility is clearly apparent.  The first half of 2017 featured dramatic moves in global bond yields and exchange rates, coupled with very muted volatility. The second half of the year promises more bumps ahead. After an extended period where both stocks and bonds have performed well, a new, more uncertain investment landscape is emerging. The good news is that S&P 500 companies are expected to post earnings growth of 9.8% in 2017, even as inflation remains under control. This will be offset by the headwind of higher interest rates as central banks are determined to say ahead of the inflation curve.

Hawkish signals from both the Fed and the ECB telegraph that central banks are moving away from their ultra-accommodative monetary policies that fueled the post-financial crisis rally. Over the last eight years, equities have been priced for low rates. With the S&P 500 P/E ratio near its highest level in more than a decade, investors are now forced to reassess whether stocks deserve such high valuations. However, if anxiety about an impending stock market collapse causes you to flee the market altogether, that might be an even riskier move.  Moderately rising rates does not necessarily means equities will drop, but it does highlight the need for profit growth to sustain rising stock prices.

Financials and technology - two sectors we are overweight on - project robust profit growth of 8% and 11%, respectively. Moreover, the massive shift towards passive equity investing is dramatically diverting liquidity into the stock market. In 2016, over $500 billion went into the ETF and mutual funds sectors alone, increasing to a staggering estimated $800 billion in 2017. For H1, the MSCI World Index was +9.4 %, boosted by the EAFE which rose by +11.8% and the emerging markets which rose +18%. The long awaited global recovery is underway. On balance, equities continue to enjoy fundamental support while bonds will remain under pressure.

Our long-term investment strategy continues intact. We remain overweight in U.S. equities and have also increased our allocation to emerging market positions. On the fixed income front, we are strongly under-weight bonds, with the exemption of  the high yield sector which is more closely correlated with broader equity trends.  Even in a moderately increasing interest rate environment, we believe that high yield bonds and high dividend-paying equities in a balanced portfolio provide both current income and capital appreciation, while muting stock market volatility. We remain constructive on consumer staples, healthcare and technology; we have increased our allocation to selected names in financial services and technology, especially those companies substantively engaged in the burgeoning global e-commerce space.
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Why Aren’t You Rich Yet?….. The reason why you aren’t a millionaire is quite simple:  the first million is always the hardest. For most people, the path towards wealth is rooted in the ways they treat money in daily life.  Here are some of the most pernicious obstacles:

1. Lack of Patience: Don’t spend money you don’t have.  Live frugally until you have some surplus. Why enrich the moneylenders?
2. Overriding Vanity: Stop comparing yourself with your neighbors and their material possessions. Who are you really trying to impress?
3. A Plethora of Bad Habits: Smoking, drinking, gambling, laziness, procrastination, sloppiness…..the list goes on. Bad habits not only result in immediate costs, they lead to other  collateral damage including poor health, wasteful  repetition, and overall inefficiency.
4. Absence of Goals: If you don’t know what you want, then you surely won’t know how to get there.
5. Lack of Preparation: Chance always favors the prepared mind.
6. Always Looking for the Short Cut: Short of a winning lottery ticker, wealth does not come quickly. The desire to get rich quickly extends into the way you invest, usually with similar results.
7. Investing in Things You Don’t Understand: Throwing money into something because it is “hot” or because someone you know made money from it will prevent you from being wealthy.
8. Blind Reliance on Others: Your broker - or your brother-in-law - may talk a good game but take a hard look at who is giving you financial advice. Look at their track record, their character and their motivations. Work with someone you respect and know well. Trust but verify.
9. Neurotic Fear of Financial Risk: Sometimes doing what feels safe can be dangerous. Cash inexorably loses its purchasing power year by year. If confronted by a bear up close, don’t run away. If someone points a gun at you, charging him might increase your chances of survival.
10. Financial Ignorance: Financial illiteracy is endemic in our society. Rest assured, your personal finances will not take care of themselves!

It is totally unproductive to think the world has been unfair to you.
Every tough stretch is an opportunity.
 -Charlie Munger
 

American Beauty (the Long, Strange Trip Begins)….. At the beginning of 2017, I opined that  the dual prospects of a Trump presidency and incremental interest rate hikes by the Federal Reserve would usher in a new year of uncertainties, the outcome of which  would be crucial for financial markets.  Out of the gate, full of missteps and melodrama, risks still abound as an untested and unpredictable American president implements his vision of America First.  In Asia, the region’s main growth driver - China - is preoccupied with managing its own economic slowdown and internal imbalances.  The U.S.-China relationship has become the paramount geopolitical nexus for trading markets.  In 2017 what happens with the Trump-driven American economy and the enigmatic, opaque China juggernaut will largely shape the tone and content of the  global growth narrative for the balance of the year.

In Q1 2017, U.S. equities turned in a strong performance, extending the post-election gains  that sent the major indices to record levels. The S&P 500’s +5.5% advance and the NASDAQ’s 9.8% rise reflected the brightening economic outlook in the U.S. The market’s resilience, supported by  solid data, has resulted in reduced volatility in spite of the ever-present geopolitical noise emanating from Washington. U.S. companies reported their strongest quarterly earnings advance of +9% since Q4 2011, providing further support for the current stock market rally. Meanwhile, the bond market, after a muted 2016 performance, finally came to terms with the long-awaited interest rate increase in February that  signaled the end of a multi-decade bond bull market. The Barclays Bond Aggregate index rose by +0.8%, with the high yield sector outperforming beating  other fixed income categories with a +2.7 % total return.

For the rest of the world, the MSCI World Index was +5.9 %, roughly in line with the EAFE which rose by +6.5%.  The long awaited global recovery seems to be well underway. The improving global economic outlook as well as more favorable stock market valuations prompted investors to reallocate funds into the emerging markets sector.  After four years of  mediocre returns, the MSCI Emerging Markets Index roared back with a +12.5% advance in Q1, led by rallies in China, India and South Korea.  Based on forward P/E ratios, emerging markets stocks are currently trading at a 26% discount to developed markets.  They represent one of the few remaining sectors in the world where valuations still look attractive.

The markets are at crossroads, at a point of indecisiveness.  After steady gains in the months after the American elections, it is pausing, neither surging forward nor falling.  The continued improvement in global economic growth and stability is offsetting the potpourri of political tensions and impasses besieging Washington, Paris and Beijing.   While equity markets appear fully valued, it becomes less so in the context of the returns available in the bond market.  Equity prices are not perceived to be rich only relative to Treasury yields.  Of course, this makes stocks vulnerable as interest rates rises to more normal levels. That notwithstanding, investors are mindful of not being on the sidelines and missing out on further gains even as high valuations, and various political uncertainties mount along the proverbial wall of worries.

Our long-term investment strategy remains well intact.  We remain overweight in U.S. equities as U.S. GDP has regained its economic footing. In recent months, we have also increased our allocation to emerging market positions.  We foresee 2017 equity returns in the high-single digits.  On the fixed income front, we are strongly under-weight bonds, with the exemption of  the high yield sector which is more closely correlated with broader equity trends.  Nevertheless, in the current low-yield environment, we anticipate that high yield bonds and high dividend-paying equities in a balanced portfolio should provide both current income and capital appreciation, while mitigating stock market volatility.  We remain constructive on consumer staples, healthcare and technology; we have increased our allocation to selected names in financial services and the global e-commerce space.

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Are You Addicted To Your Monthly Salary?….. This is the question recently posed by Nassim Taleb, author of The Black Swan.  The underlying premise is that most of us make an implicit trade when we enter the working world:  we rent out our half or more of our waking adulthood in exchange for the security and solace of a regular salary.  The implied presumptuousness of the very question itself hints at the dark side of this seemingly practical trade:  in return for daily structure and a monthly livelihood, are we unwittingly entering into a mindless servitude?

The gist of this addicted servitude is that conventional employment in our free market system can numb your mind, creativity, and is lethal to individuation. The purported fate of most employees follows a script akin to the following scenario: Getting addicted to a monthly salary is easy to fall into and virtually impossible to shake off.  In most instances, a virtual lifetime elapses, only to realize at the end, that one’s entire life was spent at a desk, working for someone else.

I didn’t know it at the time but I never encountered this most commonplace of experiences. As an immigrant and starting at the young age of 14, I always maintained multiple part-time jobs in order to afford what I wanted.  Aside from food and shelter, it never occurred to me that my hard-working parents were obliged to fund my sundry other needs and desires.

After my formal schooling, I was fortunate enough to fall into a position on Wall Street where, for a reasonable base salary, one was encouraged to learn how to use market knowledge, networking and entrepreneurship so as to derive income from invested capital.  This, after all, was the essence of investment banking.  We were motivated by personal remuneration, to be sure, but it was always in the form of base salary plus discretionary bonus.  If one performed well, over time the bonus component  could rise to 10x the base salary.  If one performed poorly, it was not too long before you were back on the street. This system of compensation engendered great striving and occasional anxiety - but never complacency!

When I finally grew weary of the demands of corporate life, it still took me a long time before I could take the bold step of becoming independent. Yes, the monthly salary is an addiction….. for even the most non-materialistic, Zen-infused minds are subject to its seductions.  This is not to devalue the employment market, as it offers plenty of benefits and security.  In fact, that structure is appropriate for the vast preponderance of workers.

However, an illusionary effect of a comfortable salary is that you believe it affords you a certain lifestyle, and when you don’t have it you won’t have the same lifestyle. Therefore, a monthly salary may prompt you to consume more than you create; and excessive consumption is an addiction. Without it, you might realize you didn’t need so much in the first place. If necessary, you learn how to make do with less, and become more flexible and inventive.

Independent entrepreneurs and ambitious people are basically dreamers. Creative and entrepreneurial dreams don’t come with a monthly salary, secure in the knowledge that the future is taken care of.  The future is never taken care of.  One has to nurture it and care for it each day anew.    In contrast to passive receipt of the secure monthly salary, each month, we are moved to think up new ideas, seek out new people, and initiate different projects. When we adapt, grow, and innovate with what we know and have…..then we are fully alive. 

Happiness is the deferred fulfillment of a prehistoric wish.
That is why wealth brings so little happiness; money is not an infantile wish.
 -Freud 

Fear and Loathing vs. Cautious Optimism ….. As with so much else in life, one’s outlook is a function of personal subjectivity.  The dual prospects of a Trump presidency and incremental interest rate hikes by the Federal Reserve is ushering in a new year of uncertainties, the outcome of which will be crucial for financial markets and an ever-shifting economic order.  In the early phases of this transition, the markets are betting that higher interest rates, coupled with lower regulation and taxes, will spur economic growth.  Less regulation and corporate tax rates would allow industry to boost profits and return capital to shareholders, while Trump’s pledged infrastructure spending will stimulate overall growth and propel commodity prices higher.

As one pundit has observed, there is an emergence of a Trump-inspired economic Darwinism that is forcing industries and countries to shake off any embedded complacency and work harder to identify and diversify their own respective sources of economic growth and innovation.  Without a doubt, risks abound as an untested and unpredictable American president and his team seek to re-energize the American growth machine, with the creation of new jobs and services and a concomitant rise in productivity.  The international markets are monitoring these developments closely. Meanwhile, Europe continues to wrestle with its own complex set of political morasses, tepid economic health and terrorist and immigration chaos.  In Asia, the region’s main growth driver - China - is preoccupied with managing its own economic slowdown and internal imbalances.  The other smaller Asian markets are closely aligned with the fortunes of the world’s second largest economy.  In sum, in 2017 what happens with the Trump-driven American economy and the still-developing, opaque China juggernaut will largely shape the tone and content of the global growth narrative that underpins market activity.

For 2016, U.S. equities turned in a surpassingly strong performance, capped by a post-Election Day surge in the major indices.  This was the year to overweight U.S. stocks, as the benchmark S&P 500 turned in a +9.5% return. The bond market, after a strong H1, finally came to terms with the long-awaited interest rate increase that likely signals the end of a multi-decade bond bull market. The Barclays Bond Aggregate index rose by +2.8%, with only the high yield sector  able to strongly outperform, beating most other asset classes with an impressive  +17.8 % total return.

For the rest of the world, 2016 was a year to forget.  Excluding the performance of U.S. equities, the MSCI World Index was -0.5%, roughly in line with the EAFE which declined by -1.6%.  China’s Shanghai Composite Index (-12.3%) and Japan’s Nikkei (+0.4%) remain mired in the exodus of capital from the turbulent currency, credit and commodities markets in Asia.  However, the commodities markets (along with commodity-driven equity markets such as Brazil and Russia), buoyed by rises in the price of oil, gold and metals, surged by over 25%, snapping the string of five consecutive years of sharply declining commodity prices.  In 2016, global market outcomes were largely a function of central bank intervention, lower investor risk appetites, and the outbreak of various economic / political / terrorist crises. Both the strengthening U.S. stock market and the dollar indeed both earned their respective status as an investor safe haven and reserve currency.

Our long-term investment strategy remains well intact.  We remain overweight in U.S. equities as U.S. GDP has regained its economic footing. We foresee 2017 equity returns in the high-single digits.  On the fixed income front, we are strongly under-weight bonds, with the exemption of the high yield sector which is more closely correlated with broader equity trends.  Nevertheless, in the current low-yield environment, we anticipate that high yield bonds and high dividend-paying equities in a balanced portfolio should provide both current income and capital appreciation, while mitigating stock market volatility.  We remain constructive on consumer staples, healthcare and technology; in recent quarters we have increased our allocation to selected names in financial services and the global e-commerce space.

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What Investors Don’t Know….. Even as financial information and sophisticated financial engineering become ever more accessible to most investors, it has not helped otherwise smart people do stupid things with their hard earned money.  The irony is that the “average” investor routinely lags the “average return by 4 to 7 percent each year.  This is as true for the so-called “mom-and-pop investor” as for well-paid institutional portfolio managers.  Investors are constantly seduced by the illusion that they or some expert knows something that will help them “beat the market.”  Unfortunately, neither market pundits nor unctuous hedge fund managers are very good at the prediction business.

So how does one debunk all the wrongheaded notions that continuously besiege the active investor?  Rather than constantly trying to “time the market,” it is almost always better to select solid companies at a reasonable price and learn to be patient.  For most people, wealth does not come quickly.  This desire to get rich quickly extends into the way we invest, usually with similar results.  Invest in assets you can understand.  Absorb information and ideas from others but investing decisions are ultimately your own. Recognize that you may be wrong and remain mentally nimble.

Building a long-term portfolio that supports and enhances your wealth requires ongoing work, effort and discipline.  It does not magically happen to the vast majority of investors. Prudent and active investing is an ongoing, cumulative kind of task that is part hard work, part artistry and demands a generous understanding of human nature.   If the process of investing, trading or speculating is associated with thrill-seeking, entertainment or easy riches, might I suggest that you place the bulk of your investable funds in passive index funds in accordance with conventional asset allocation principles.  Then use your time and energy in pursuit of other endeavors that may, as Freud has suggested, yet allow for the deferred fulfillment of some other infantile wish. 

If I had to relieve my life I would be even more stubborn and uncompromising than I have been.
One should never do anything without skin in the game.

If you give advice, you need to be exposed to losses from it.
 -Nassim Nicholas Taleb 

Trumped by Randomness….. Given the messy state of the world - not to mention the sordid state of American electoral politics -  the markets are exhibiting an admirably equable stance.  At the three-quarters mark,  professional investors are taking the unpredictable tumult of global news in stride. That notwithstanding, a dispassionate review of 2016 YTD reveals an investment scene ambivalent and muddled, and an investment mentality turned upside down. Reflective of this asymmetry,  bonds have provided welcomed capital gains while equity investors have scrambled to purchase higher dividend stocks to obtain current income.

Equities turned in a respectable performance in Q3, doing  a bit of catch-up as the bond markets took a pause from their robust performance in 2016. The global equity indices are now slightly positive at +3.8% YTD, with even the EAFE getting close to break-even for the year..  The U.S. continues to fare much better than other  regions, truly earning its safe haven status for nervous investors. The benchmark S&P 500 clocked in at a respectable +6.1% YTD.  Within U.S. equities, stocks that have bond-like characteristics such as utilities, telecoms and consumer staples have been the biggest winners.  Investors are desperately seeking income and stability and seem willing to pay for for it.  Hedge funds continue to underperform the broad market indices in 2016, as major names are finally capitulating after years of mediocre performance. Can one be accused of a degree of schadenfreude when marquee names in this rarefied space close up shop or drastically reduces their usurious fees?

Outside of the U.S., Europe and other developed markets, volatility is even more conspicuous.  China’s Shanghai Composite Index (-15.1%) and Japan’s Nikkei (-13.6%) remain mired in the exodus of capital from the turbulent currency, credit and commodities markets in Asia.  For the balance of 2016, global market outcomes will be a function of central bank intervention, investor risk appetite, and the outbreak of any further economic / political crises.  Central banks have moved quickly to stabilize market conditions.  The ECB is pumping more liquidity into the system while the BOJ is trying to mitigate the appreciation of the yen.  In the U.S., the Federal Reserve is likely to implement a modest increase in interest rates prior to year end. For now, we believe global risk appetite is still high enough to support equities in the coming quarter.

Our long-term investment strategy remains well intact.  We remain overweight in U.S. equities as U.S. GDP continues its slow recovery phase. We still foresee 2016 equity returns in the mid-single digits.  On the fixed income front, bonds continue to achieve steady, above-average returns.  In the current low-yield environment, bonds and high dividend-paying equities in a balanced portfolio have been a welcome tonic in the face of near-term stock market volatility.  Our longstanding positions in investment grade and high yield bonds, as well as in high-dividend stocks continue to supplement portfolio performance while mitigating market volatility.  We remain constructive on consumer staples, healthcare and technology; in recent quarters we have been increasing our allocation to selected names in the global e-commerce space, as that increasingly large and innovative industry represents one of the fastest growing sectors across global markets.

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Pessimism and the Logic of Insecurity….. The legendary investor George Soros has said:  “I am not a professional security analyst.  I would rather call myself an insecurity analyst.  I recognize that I may be wrong.  This makes me insecure.”

Reflecting this sentiment, a sense of pessimism is pervasive these days.  This gloomy outlook is evident not only in the dispiriting rhetoric of the current political scene but in the extreme pricing of major asset classes in both equities and bonds. The insatiable demand for safe-haven assets has driven 10-year US government bond yields down to 1.6%, near its all-time lows.  This situation is even more exacerbated in Germany and Japan, resulting in heretofore previously unimaginable nominal negative bond yields.  This fear factor is also at play in equity markets, as the valuation of defensive stocks with high dividend yields - or the bond substitutes of the equity market - are trading at historically high levels. This raises the obvious question of what really constitutes “safe investments” these days?

Wall Street is engaged in a never-ending battle of cognitive dissonance. On the one hand, it likes to take risks—especially with other people’s money. On the other hand, it likes to mitigate as much risk as it possibly can.  Most people assume that Wall Street is a swashbuckling place filled with iconoclasts swinging for the fences. In reality, the constant scrutiny of market validation or repudiation heightens investor insecurities and fears. Whereas the investment process was once portrayed as the epitome of a kind of bloodless, quantifiable rationality, we now know that emotions play an inordinate role in our understanding of intuitive judgements and investment choices.  In practice, Wall Street appreciates boring predictability most of all, with an occasional twist of volatility to get the juices flowing.  For our part, we can easily tolerate “boring and predictable.”

Yet despite the confusion over the ever shifting moods and identities of the investment marketplace, one does finally begin - in jagged little pieces - to understand and appreciate the elegant multidimensionality of it all.

Wall Street people learn nothing and forget everything.
 -Benjamin Graham 

Bewitched, Bothered and Bewildered….. At the halfway mark, if the professional investor is not confounded and confused, then he really doesn’t know what’s going on!

The latest shock to the global financial system - namely Brexit - came and went (or so it seems) if one were to only look at the major equity indices as a barometer of investor sentiment.  Within the confines of a week, hysterical panic turned into ……hysterical hopefulness.  A sober review of the first half of 2016 shows an investment scene ambivalent and muddled, and an investment mentality turned upside down.  Bonds have provided abundant capital gains while equity investors have been forced to purchase higher dividend stocks to obtain current income.

Even with the boost from a rally in the last few days of Q2, global equity indices are still slightly underwater at -0.6% YTD, with the EAFE -6.3%, hit particularly hard by the cascade of economic and political woes afflicting Europe.  The U.S. continues to fare much better than other  regions, truly earning its safe haven status for nervous investors.  Moreover, bonds have represented the sweet spot for investors in 2016, particularly U.S. Treasuries and high-yield bonds up 8-9% YTD.  Within U.S. equities, stocks that have bond-like characteristics such as utilities, telecoms and consumer staples have been the biggest winners.  Investors are desperately seeking income and stability and seem willing to pay for for it.  Hedge funds continue to underperform the broad market indices in 2016, and as one quick-witted pundit puts in, have essentially become a hedge against attractive returns.

Outside of the U.S., Europe and other developed markets, volatility is even more conspicuous. In the latest example of how “the last-shall-be-first”, beaten down commodities markets rebounded by over 20% in the first half of 2016, commodity-oriented markets such as Brazil returned 46% (powered by the rebound in the Brazilian real), along with Russia which returned 20.4% (also boosted by a strengthening ruble).  Currency fluctuations really matter for global investors, often more than the local stock market action.  Conversely, China’s Shanghai Composite Index (-17.2%) and Japan’s Nikkei (-18.2%) remain mired in the exodus of capital from the turbulent currency, credit and commodities markets in Asia.

For the balance of 2016, global market outcomes will be a function of central bank intervention, investor risk appetite, and the outbreak of any further economic / political crises.  Central banks are already moving quickly to stabilize market conditions.  The ECB is pumping more liquidity into the system while the BOJ is trying to mitigate the appreciation of the yen.  In the U.S., the Federal Reserve is likely to pause in its plan to gradually raise interest rates. For now, we believe global risk appetite is still high enough to support equities in the coming quarters.

We remain overweight in U.S. equities as U.S. GDP should continue its slow recovery phase. In the aftermath of Brexit, global equities rallied to end the first half slightly positive for U.S. stocks.  On the fixed income front, bonds continue to achieve steady, above-average returns.  In the current low-yield environment, bonds and high dividend-paying equities in a balanced portfolio have been a welcome tonic in the face of near-term stock market volatility.  Our longstanding positions in investment grade and high yield bonds, as well as in high-dividend stocks continue to supplement portfolio performance while mitigating market volatility.

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Why Mr. Market has a Personality Disorder…... Why does the market plunge one day and then soar the next, with no apparent reason?  What does it imply about the future?  Why don’t the experts have a clue?

Attempts to predict or explain daily stock movements are futile.  Even though it sounds like a caricature, often investors sell stocks because… prices are falling, and they buy stocks precisely because… prices are rising.  It is the perverse opposite of expected consumer behavior.  It is as if your local shopping mall announces that prices on all merchandise are temporarily raised by 10% and it triggers a stampede of hysterical shoppers into the stores.  Beyond the curious irrationality of investor behavior, one of the most vexing clinical conundrums for the long-term professional investor is how to assess and respond to the ceaseless cacophony of information, opinions and noise that emanates from the global investment community.  This phenomenon is abundantly manifested on the behavioral, cognitive and emotional levels.

There are some explanations why investors sabotage their own financial interests. Most investors rely on “experts” to take care of their money.  They believe that others have more knowledge about investments and rely exclusively on their judgement.  The problem is that, in many cases, the ones who claim the most loudly that they have the correct crystal ball, turn out to be the ones  who merely produced the most seductive marketing pitches. Their primary objective is to get you to hand over your money. Sometimes the sad truth is that those who don’t know speak the loudest, while those who do know have no need to broadcast their knowledge.

Other reasons why investors act like sheep is that they invest in things they don’t understand. Investing in something because someone else has made money without fully understanding the investment rationale is why markets, in the short term, rise and fall without  any consistent logic.  The corollary to investment ignorance is the fear of risk.  When we are so scared of risk that we keep most of our money in cash (which actually loses real value over time) or sell at precisely the most inopportune times because prices are falling, that is when we act as our own worst enemy.  These common investor responses illustrate why investing is a discipline where theory and practice collude with investor anxiety.  The constant scrutiny of market validation or repudiation heightens investor insecurities and fears. Whereas the investment process was once portrayed as the epitome of a kind of bloodless, quantifiable rationality, it is now accepted wisdom that emotions play an inordinate role in our understanding of intuitive judgements and investment choices.

To the astute long-term investor, it is clear that Mr. Market is mentally unstable.  We know how to live with him but, with hard-earned experience, have learned to monitor his eccentricities closely!

The one who follows the crowd will usually go no further than the crowd.
The one who walks alone is likely to find himself in places
where no one has been before.

  -Albert Einstein 

Instincts and Their Vicissitudes….. After a panicky decline in January and February, the major equity indices rebounded in March to end Q1 roughly unchanged from where they began in 2016. From an inauspicious negative return of 11.3% through February 11, global equities rallied to end the quarter slightly positive for U.S. stocks and slightly negative for other major global indices. This was an abbreviated version of the market action throughout 2015.  Like a roller coaster that leaves you where you started, one is left with a somewhat nauseous sensation. So much anxiety, so little to show for it!

The hysterical gyrations in certain sectors - oil has rebounded 46% from their 2016 lows, the USD has fallen 4% against a basket of currencies in Q1 - were counterbalanced by easy-money policies from major central banks and relatively benign U.S economic data.  The net result was that the DJIA and S&P 500 showed nominal gains for Q1 while the MSCI World and EAFE indices extended their 2015 losses.  Amid global turbulence and sluggish economic growth, gold (of all assets classes) surged 16% in Q1, while Japan’s Nikkei and the Shanghai Composite  shed 12% and 15%, respectively.  Suffice to say, it has not be an easy period to make market prognostications.

Recent market action has confirmed the pitfalls of hasty decision-making during times of turbulence.  If an investor panicked in January and February, he would be looking quite foolish now because of the recent recovery.  The equity markets continue to demonstrate its stability and resilience in the face of multiple weak underpinnings.  Perhaps the best observation for 2016 is that it is a period of low expectations.

On the fixed income front, bonds continue to achieve modest but steady returns. This is in stark contrast to the pundits who predicted steadily rising rates (and thus lower prices) in 2016. The yield on the 10-year Treasury note remains well below 2%, and the high yield bond sector rebounded with a 3.3% return in Q1.  Expected modest incremental interest rate increases in 2016 by the Federal Reserve should provide solace for bond investors.  In the current low-yield environment, bonds and dividend-paying equities in a balanced portfolio serve as a ballast against near-term stock market volatility and also generates a welcome source of current income.

Global equity markets  remain fragile, against the backdrop of a fully-valued stock market.  The S&P 500’s trailing price-earnings ration of 18.2x is now meaningfully higher than its recent 10-year average of 15.8x.  Stocks need earnings growth in order sustain this recovery.   On the bright side, low absolute interest rates are driving investors towards riskier assets and the relative political stability of North America keeps us in the envied position as the world’s safe haven for both stock and bond investments. The U.S. markets still represents an attractive combination of moderate growth and stability, while Europe and Japan are now arguably cheaper than they were a year ago. On the current income front, our longstanding positions in investment grade and high yield bonds, as well as high-dividend stocks continue to supplement portfolio performance while mitigating market volatility. It is not surprising that the current favored equity categories are defensive bond-like industries such as utilities, telecoms and consumer staples.  Furthermore, our ample cash positions enable us to act quickly if the recovery in prices seem sustainable.  Accordingly, we are overweight U.S. large-cap defensive names, including health care, pharmaceuticals and consumer non-discretionary businesses.

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Thinking Fast and Thinking Slow….. Professional investors, particularly those who favor actively managed portfolios in pursuit of outperformance, should perhaps spend some time on the couch.

One of the most vexing clinical conundrums for the long-term professional investor is how to assess and respond to the ceaseless cacophony of information, opinions and noise that emanates from the global investment community.  This phenomenon is abundantly manifested on the behavioral, cognitive and emotional levels.  Institutional Investors are generally rational and their thinking is typically sound, but sometimes emotions corrupt their rationality and biases disrupt the machinery of their cognition.  The Nobel laureate Daniel Kahneman has pioneered the role of heuristics and biases when individuals make decisions under uncertainty.  While this approach can be applicable to many endeavors, it is hard to imagine a more dynamic and relevant laboratory than the world of investment management.

Investing is a discipline where theory and practice colludes with investor anxiety.  The constant scrutiny of market validation or repudiation heightens investor insecurities and fears. Although the objective of investment performance requires an integration of all available market information and listening to others, listening to and following one’s own investment convictions is an essential part of being able to flexibly think about and respond to market vicissitudes. Whereas the investment process was once portrayed as the epitome of a kind of bloodless, quantifiable rationality, it is now conventional wisdom that emotions play an inordinate role in our understanding of intuitive judgements and investment choices.  The accurate intuitions of so-called investment experts can usually be explained by the effects of prolonged practice as much as by any investment heuristics.

The mythologizing of expert intuition - the very foundation of our hyper-active investment media and information industries - is predicated on the premise that successful investors see the investment landscape very differently than the casual investor.  Like a chess master surveying the complex scenarios on the chess board, he can choose to buy or sell a stock quickly and intuitively.  This pivot towards a spontaneous expert answer is the so-called “thinking fast” of Kahneman’s famous book on the subject.  Fast thinking involves variants of intuitive thought as well as the automatic mental activities of perception and memory. The problem  is that   thinking fast often results in the wrong answers. Alternatively, especially in times of market turbulence, investors find themselves switching to a slower, more reflective form of thinking.  This is the “thinking slow” that requires a more deliberate, effortful and statistically-based path to investment choices and judgements.

The distinction between these two metaphors of fast and slow thinking captures well the mental life of active investors. Recent research suggest that the kind of intuitive fast thinking is far more influential in investment decisions than previously acknowledged, wherein automatic and unconscious processes are often the determinants of portfolio performance.  We have difficulty thinking statistically because statistics require thinking about many things at once.  This describes  a puzzling limitation of our minds:  our excessive self-confidence, our inability to acknowledge our ignorance and the uncertainties of the world we live in. In other words, we are  constantly (in the words of author Nassim Taleb) “fooled by randomness” and give woefully insufficient weight to sheer, dumb luck.

When we better understand the distinctions between our “fast thinking” and “slow thinking” self, our experiencing self and our remembering self,  we will be better positioned to reconcile our two selves in a single body. Perhaps then, investors can spare themselves unnecessary investment pain in their pursuit of investment happiness.  I, for one, am inclined to think fast; but for the sake of my financial health, I endeavor to think slow.

It was never my thinking that made the big money for me.
It was always my sitting. Got that? My sitting tight!
 -Jesse Livermore

The end of 2015 was hailed by nearly all market participants with relief, as a year full of angst and disappointment came to a joyless conclusion.  The primary index of U.S. stocks - the S&P 500 - posted a nearly 1% loss while most other equity indices fared slightly worse.  This was the first annual loss since the horrific 2008 year and suggested that the post-recession market recovery has finally run out of steam.  The MSCI World Index, EAFE and Dow all slumped in sympathy, with returns of -2.8%, -3.3% and -2.2%, respectively. In summary, 2015 was a volatile, trend-less affair, with a deep summer slump brought on by anxieties of a China slowdown, followed by a bounce back in Q4 that left market prices just slightly below where they started at the beginning of the year.

That notwithstanding, even the gloomy cynic may find a silver lining in the market’s tepid performance.  Given all the problems and headwinds in the trading environment - weak corporate earnings, anemic GDP growth in most major economies, a meltdown in commodity prices, and the proliferation of geo-political tensions throughout the world - the fact that most equity markets finished the year virtually unchanged merely demonstrates its stability and resilience in the face of multiple challenges.  For the optimist, the low expectations set by 2015 may make 2016 a better year.

At the end of Q3, the markets experienced a correction of 12% in August and September, then in Q4 rallied and faded again in November and December.  In the month of December, a plunge in energy and other commodity prices and the Federal Reserve’s first interest rate increase in nearly a decade triggered anxiety among bond investors, especially in the high yield bond sector.  U.S. Treasuries were the beneficiaries of the flight to safety, returning 1.2% in 2015. The conspicuous exception in the fixed income category was high yield bonds which turned in a disappointing performance of -4.3%, in large part attributable to the big decline in issuers in the energy sector.  Expected further incremental interest rate increases in 2016 will present more headwinds for bond investors.

In the current low-yield environment where 10-year Treasuries are hovering around 2%, the main role of bonds in a balanced portfolio are to serve as a buffer against near-term stock market declines. Stocks, in a extended bull market that is now seven years old, will be vulnerable in the ensuing several quarters. Moreover, continuing concerns about China and other emerging markets are causing investors to take a more pessimistic view of market performance. In the first half of the new year, the credit markets (with its prospects of increased interest rates) and the new uncertainties over China, will create turbulence.  Accordingly, a flat to 5% rise in 2016 may represent an optimistic scenario for equities.

Global equity markets will remain fragile and any negative news will likely be met with exaggerated selling pressure.   On the bright side, the continuing strength of the U.S. dollar and the relative political stability of North America keeps us in the envied position as the world’s safe haven for both stock and bond investments. The U.S. markets still represents an attractive combination of moderate growth and stability, while Europe and Japan present some selective opportunities for the value investor. On the fixed income front, we retain our longstanding positions in high yield bonds despite their under-performance in 2015, as they now represent a more compelling risk-return asset category. For current income, we lean more on high-dividend stocks over fixed income alternatives.  We have also boosted our cash position in anticipation of further price volatility. Within equities, we have moved to an underweight position in both non-U.S. developed markets and emerging markets; accordingly, we are overweight U.S. large-cap defensive names, including health care, pharmaceuticals and consumer non-discretionary businesses.

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Finding One’s Analytic Voice….. Professional investors are confronted with many ideas about how to achieve effective investment performance.  During the arduous process of long-term investing, it is easy to lose track of oneself amidst the unrelenting chorus of so-called experts and market pundits.  For many investors, it feels comfortable to adopt the passive and safe role of accepting guidance from others, especially those who wear a mantle of authority.  However, as the investment world becomes continually more complex, we are bombarded with choices and decisions about what sort of investor to be, which market prognostications to follow, and how to implement our own investment strategies.

Investing is a discipline where theory and practice colludes with investor anxiety.  The constant scrutiny of market validation or repudiation heightens investor insecurities and fears.  Listening to and following one’s own investment convictions is an essential part of developing confidence and being able to flexibly think about and respond to market vicissitudes.  Although the objective of investment performance requires an integration of all available market information and listening to others, there are times when choosing one voice is essential, if only to maintain the integrity of one’s investing style.

Often, in the midst of market turmoil and cacophony, it is important to realize that the state of not knowing is a perpetual one for investors.  In fact, after many years at this, I can allow myself to not know.  I can relinquish the reflexive tendency to wish that there are others with answers.  I no longer need to turn to others for unknowable answers to market uncertainties.  Investment and market knowledge, which is continuously constructed anew, is extremely difficult to ascertain, much less predict.  Who is up and who is down changes with the seasons. It can be uncomfortable to sit with so much uncertainty, and so we fill the void with theory, conventional wisdom and second-guessing.  As professional investors, we need to constantly assess our fundamental investment thesis and be prepared for change.   The investment world has always been a curious place and the impulsive sheep-like behavior of investors makes it even weirder yet.  For contrarians and long-term investors, this curious state of affairs offers us a world of investment opportunities.  To truly take advantage of it requires us to find and articulate our own analytic voice.  This is the loneliness of the long-term investor.