My earliest football memories are of the 49ers winning Super Bowls. It’s all I knew. Year after year my team made the playoffs. They won 5 Super Bowls. The 49ers were so good for so long – we all had it so good for so long – that when the end finally came and stole both our breath and our hall-of-fame quarterback, the only proper response we could muster was denial.
“It’ll be OK.”
“We’ll come back.”
“All they need is a new QB.”
Two decades of dominance had re-written our definition of normalcy. It was time for reversion to the mean.
But we didn’t just revert to 8-8. As reversionary phenomena tend to go, we plunged far below the historical trend line. In the decade to follow the 49ers would not just field some bad teams, but some of the worst teams of the modern era.
We all suffered in silence and other franchises watched our denial give way to anger, bargaining, and ultimately depression. Some of us gave up and turned the TV off on Sundays. We found other things to talk about at our weekend barbecues.
The exact same thing happened in the stock market, of course. We had it so good for so long. Our world imploded and the last decade has given us a new definition of normal. We reverted well through the mean into the land of extreme negativity and market depression, but today we’re finally starting to adjust. We see the world a little more clearly now and have a better sense about the risks and rewards.
We all enter the market as children. We study history and we pay attention to the late night stories our fathers share, Glenlivet or Budweiser in hand, of the grisly struggles of yesterday. But we all enter the market as children. We write our own history and the stories that we’ll some day tell our sons will inevitably be our own, not the ones of our fathers.
Every cycle begins and ends with hope. This has all happened before and it will all happen again. Sports teach us this. Literature teaches us this. The Buddha teaches us this. We try and teach others about this but the only way they ever learn is to experience it for themselves.
I will confess, however, that the exact parallels of today are borderline supernatural. A revolutionary new coach out of Stanford immediately puts the Niners back on the map. A near-rookie unseats a perfectly-adequate veteran and leads them to the Super Bowl. A groundswell of local hope invigorates the West Coast. Investors finally start taking risks just as the market approaches an all-time high…
Personally, I want to believe that this is the start of something great. I want to believe .
But I have a better sense now of what constitutes normal. I’ve ridden through my own peaks and valleys. I have more appreciation for everything that falls above it and I have less fear of everything that comes below. I feel like this is the kind of thing my dad would have explained to me back when I was a kid, back when he was teaching me to throw like Joe Montana. I wonder if he, at the time, understood the paradoxical necessity and futility of such gestures?
Today I’m experiencing the same feelings he did back in the 80′s. I’m excited again, ready to drink deep after a long journey through the desert. Instead of having been spoiled by greatness, I appreciate the magic.
This wisdom comes with a cost, of course: skepticism that it will last rather than the naive optimism of inexperience. But sacrifices like these are what make life mysterious and worth fathers sharing with their sons.
I’m appreciating this market too. I’m now on public record that this year the market is going to make a new all-time high. What happens after that is anybody’s guess. With a fair-to-slightly-expensive market valuation and a bevy of reasons for slower secular economic growth, my strategic brain is telling me to be more defensive than I would have been in those decades of dominance. The market probably has a string of 8-8 seasons ahead of it after this year, and one or two possibly like that 2-14 year when I was born and that kid out of Notre Dame took the helm.
Our Cyclical Journey
You can still make money in a market like that. It takes a bit more work, but you can do it.
Before making my predictions for the year, I wrote a little bit about my process. I like to look at assumptions that the rest of the world regards as truths. Then I do some thinking and some fundamental analysis about where it makes sense to push back. I call it speculative judo.
One of these assumptions that the world regards as a truth right now is that it’s difficult to beat the market and that investors shouldn’t bother trying. It’s that great Bogle-ian idea that investors are simply better off just buying an index fund and forgetting about it. This idea dominated market thought up until the early 2000′s then disappeared during a few nasty bear markets when all of a sudden, yeah, it was a pretty terrible strategy to just buy the market. But the idea has re-emerged in the last year or two. (During the 2005-2007 peak we were much more focused on becoming mini real estate tycoons.)
The closer we get to that new all-time high, the louder I hear this strategy. Even if investors don’t actually act that way, most of them still dispense that same advice. Everybody knows this. It’s a financial truism. Don’t try and beat the market.
I know that there are totally legitimate reasons why this is true, the biggest of which is fees. Between what you pay for transactions, for the mutual fund manager, the fund administrator, and your RIA, it’s a statistically-significant enough hurdle to overcome. It’s 2-3% per year or more. That’s meaningful when when you compound it over the long run.
The good news is that fees have come way down. You can buy a sector ETF and pay 0.5% or less. The iShares Total Market ETF (ITOT) charges 0.07%.
While I wouldn’t bet we enter a world where 80% of professional money managers beat the market instead of the 80% that don’t do it. I do think it’s easier to beat the market than it used to be, or it least during the next market cycle, it will be. Maybe it’ll move towards 30/70 or 40/60 for who beats the market in a given year and maybe the average margin of victory the market enjoys over professional managers shrinks. I realize suggesting such a trend such constitutes heresy.
The basic Vanguard advice of “buy an index fund and hang out” was legitimately good advice at various points during the last few decades. Because of the whole fees issue, it’ll always remain a strong equity strategy. At least in theory. But does it even matter if the overwhelming majority of investors lack the discipline required to practice it? Trust me. I play a lot of games. Theoretical strategies and practical strategies are totally different things, especially when money is on the line.
Plus, the world has changed dramatically and because it’s so much cheaper to diversify in fundamentally meaningful ways, I don’t think it’s crazy to suggest the strategic advantage basic index buy n’ hold has enjoyed shrinks. And to top it off, I’m a natural skeptic: why should anything that was good advice for the last few decades necessarily be good advice for the next few?
I’ve spent a lot of time in the last few months meditating on this idea. Those of us who work in the business and who have our incentives aligned with those of our clients (rather than pushing them endless amounts of new product), know that a better way is easily within reach.
Intelligent, disciplined asset allocation.
Honestly, the best lesson of the last market cycle is that asset allocation works. Sure, you sometimes under-perform the market when it’s going up and you’re tempted to abandon your discipline, but when the market starts going down you sleep a heck of a lot easier. After spending my career on the outer banks of finance, I’m confident that it’s much easier to beat the market when it’s going down than when it’s going up. I just wish our brains and our financial culture were wired in such a way to make that psychologically easier to embrace.
Asset allocation is step one. If the rest of this decade looks the way I think it might, now could quite possibly be the perfect time to start employing a practical strategy such as this. Even if this is the beginning of a new secular bull market — and it might be! — disciplined asset allocation will help you handle the little crashes along the way, none of which you will not see coming. If not financially, then emotionally.
Going one level deeper, when you look within the stock market component of your allocation mix, I think there’s a simple way to enhance it. There’s an easy way to beat the bear cycle and still perform well enough if that doesn’t happen:
- Overweight stuff that pays a growing dividend.
- Avoid the stuff that is obviously bad.
That isn’t a sexy stock strategy. It sounds like common sense and I’ve been talking about it since we launched this letter in 2009. But it’s one that I think beats the market over a 20-year window. And it’ll beat the pants off the market when it comes to risk-adjusted return.
In the meantime, stay tuned this year and in the years ahead while we talk about more specific opportunities within interesting global markets.
Next week I’m going to launch something I am really excited about. It’s an all new service, a complementary newsletter to this one. This is a Passion Project and it’s one I’ve had simmering on the back burner since 2010. A few things finally fell into place and I added those last few ingredients to make it table-ready.
In recent years, I’ve become obsessed with the following idea:
The shift from a commission based financial advisor model to a flat fee model was an immensely positive one for clients. But it’s created a bit of a gap between wealthy investors and normal investors when it comes to investment strategy and planning. The industry’s best financial advisors tend to focus more exclusively on high net worth relationships. As their operations rightly should. When you only charge 1% and can’t churn your clients account like the good ol’ days, it can be difficult for an RIA to profitably serve an investor with a $50k, $100k, or even a $250k account. Small investors are left out in the cold on their own or relegated to a third-tier advisor who’s desperate for business and spends all his time recruiting new clients rather than building excellent investment portfolios for the ones he’s already got.
I want to help fill this need. I don’t know how else to describe it. It’s almost a crusade. I believe in my soul it can be socially useful and if I do it right, I believe there are financial rewards to be had. Who said I’m a heartless skeptic?
My solution is far from perfect. But it’s a step in the right direction. I’ve been sending it out to investors big and small, sophisticated and admittedly ignorant, and based on their feedback I’m very encouraged that this will be a valuable service to a meaningful chunk of that independent retail market.
See, I’m going to show you how to do all this. How to build and manage a strategically diversified portfolio. Exactly. Step by step.
And I’m going to do it with accessible language and a design aesthetic that properly reflects the quality of the underlying strategies. And finally, I’ll be able to have an official, quantitative public benchmark on how my specific investment ideas perform, at least the ones that an average investor at home can easily implement.
There are others already in this space. It’s time to see if I can do any better. I’m going to need your help, though, and starting next week I’m going to need your feedback and suggestions to make it the best service that it can be.
Independent investors, stay tuned. And if you do want specific help with your portfolio, the good news is that I’ve gotten to know some great investment advisors over the years. A lot of them read this newsletter and my thinking has been influenced in part by some of their strategies. A good financial advisor is an immensely valuable thing, but like most valuable things, they can be hard to find. I’m always happy to make an introduction to some of these guys, just send me an email.
Lessons from our fathers
Everything we do has a generational component. From the way we invest to the teams we root for and why. It shapes how we evolve, our generational independence.
You get old. You gain wisdom. You become a better fan, a smarter fan. A better investor. And then you die. And no matter what you write and no matter what stories you tell, the next generation has to learn its own lessons on its own terms.
I’ve done that, learned my own lessons in my own way. My guess is that you probably have too.
It was impossible for me to realize it at the time, but Joe Montana was the man my father wanted me to become. Not a star quarterback in the NFL, of course, but a man who would stay cool as the pocket collapsed around him and who never let overwhelming pressure rule out the possibility of a 4th quarter comeback. Those qualities were necessary in his field, commodities trading. Joe Montana was an inspiration for him.
I wound up with those qualities — or at least I like to think I did. Not because he taught them to me, but because that’s the kind of guy he was and in me is a part of him. I now see the importance of those qualities too, but only because of my own experiences.
Unlike my father, I’ll have the chance to explicitly teach my own kids the value of being able to stay calm under duress. But they won’t listen and it won’t take. I’ll tell them how awful the 49ers used to be and how difficult it used to be to make money in the markets. They’ll smile and nod and get their hopes up for yet another Super Bowl run and another year in the bull market. They’ll probably buy a second home right after three straight years of 15% real estate gains.
And that’s OK. Their generation will learn its own lessons in its own way. That’s just the way it works.
The good news is that if keep my mind open, I’ll learn plenty from them too.