Living With a Lack of Conviction
- Today’s market environment has generated a great deal of uncertainty amongst investors
- There are several strategies that investors can employ when conviction about the future is in short supply
- Globalization, emerging markets and technology are just some of the things that make this time different and more complex
The phrase “to have conviction,” in a non-legal sense, means to hold firmly to a belief or opinion regarding what one says. To apply the root of the word, if you have conviction, you are “convinced” that a certain outcome is, or will be, correct.
Conviction Exists in this Market, but is Limited and Carries Risks
Today, in the world of investments and macroeconomics, it appears there is a surplus of uncertainty and a deficit of conviction. Consensus notes that a market decline and associated recession is in our future sometime in 2020, unless it comes earlier or later.
Investors also generally agree that the run of a dominant cap-weighted S&P 500 and growth stocks must be nearing the end. But, few are willing to hazard a forecast of what will be the catalyst for change or when that might occur.
There is agreement that the dominance of the USD and the American stock market versus the rest of the world is unsustainable. However, it is a rare investor that seems willing to put up by shifting assets away in any meaningful fashion. It is unquestioned that credit spreads at current levels are setting up for a reversal that will reward the holder of risk-free assets. Yet even these modest spreads are enough to coerce investors to reach just a little longer for extra yield.
What we have just described are the characteristics of a world that has become unsure. Conviction seems to be based upon three distinct points of view regarding how to manage in this uncertain world:
- Stay the course over the long term. Diversification and mean regression will ultimately prevail;
- My “book” is my “book,” whether it is active or value or global or whatever. I will keep flogging it as the one true solution despite the fact that my knees are getting a little wobbly from so many quarters of underperformance; or
- The crystal ball of being vigilant about macro and micro influences will enable me to escape whatever sea change awaits. I will sell (cap weighted, U.S., high yield, etc.) just in the nick of time to avoid a calamity.
There is some truth in all of these perspectives. Mean regression may be the most powerful force of nature, and passionately believing in some basic philosophical truths allows an investor to look past aberrations and avoid the whipsaw.
There is also no doubt that although market timing has a bad connotation for many, it is possible to pick up some nuggets of predictive power and cut off at least some of the tails of the return distribution.
Yet each of these viewpoints also carries risk.
- Does the investor have the discipline to stay the course or will he or she capitulate at exactly the wrong time selling into bottoms and buying into tops?
- Has the passion for a style or approach turned into blind zealotry preventing any degree of reexamination of basic principles?
- Does the investor shifting allocations become inordinately convinced of his or her skill such that it becomes overvalued? Or, does the investor become so insecure based on past shortfalls that he or she fails to act in the face of even overwhelming evidence of the best path?
What Should Investors Do When Conviction is In Short Supply?
Our view is that each of the three approaches to managing investments in a nebulous world, with effective implementation, has value and should be employed by investors.
Diversifying and rebalancing to take advantage of mean regression does not always work – but their power is substantial over time. The evidence of this is academically and empirically strong. Markets are, despite the advent of algorithmic trading, mostly driven by humans. Humans have an innate tendency to want to buy good and sell bad.
This creates overcorrections and anomalous market conditions. Consistent application of solid policies to diversify and rebalance can offset at least some of this influence.
A fundamental belief system is likewise a rational support for long-term success, and is one area where conviction of ongoing validation of that belief system should never be in short supply. Investors grounded in basic principles will not always be right, but they likely will always know where they stand. Talk to an asset manager about their portfolio – or the algorithm they use to create it – if they don’t feel strongly about what they hold and why they hold it, how will they react to the inevitable setbacks to their thesis?
Finally, we see value in non-beta-driven (absolute return) approaches, including some forms of hedge funds (hopefully with fees cheaper than “2 and 20”). These include multi-asset class strategies that combine all three of these features (rebalancing, a belief system, and the ability to make reasoned shifts between various exposures). The objective of these strategies is to be a potentially valuable contributor to achieving long-term return goals with a risk pattern that is less driven by largely unpredictable moves in the capital markets.
This Time Really Is Different
Sir John Templeton once said that the four most expensive words in the English language are “This time it’s different.” By which, he likely meant the fallacy of notions such as the tech bubble would never break, that housing prices would go up forever, or that the cap weighted S&P would forever be victorious over those active managers.
We believe, notwithstanding Sir Templeton’s wisdom, that this time is different. It is different because it is so much more difficult. We have had the wind at the back of fixed income for the better part of 30 years – that is highly unlikely to be repeatable. The globalization genie is out of the bottle, and attempts to put it back in create substantial global uncertainty.
The emerging world, particularly China and India, are moving towards consumerism with a rapidity and magnitude that may dwarf the ascendance of the United States post the industrial revolution. Vast untapped wealth lies in the people and resources of Africa, South America, and Southern Asia.
To say that news and information has become a 24/7 global phenomenon does not adequately describe the reality of the various mediums blasting at us from all quarters, all of the time. We seldom just watch CNN/FOX/MSNBC, but also stream while we watch, listening to something else, and while viewing a video of people in another world playing video games. Each generation can point to events and circumstances and say, “wow, look at all of these challenges, changes and opportunities,” but never before at this speed and breadth. We are becoming the planet that science fiction writers were describing in their fanciful visions.
Importantly a natural reaction to information overload and rapid change is a lack of conviction about the future – uncertainty begets inaction. There is, however, at least one truth that seasoned investors recognize in considering such environments – it is hard to make money when there is a consensus of conviction because the money has already been made.
With uncertainty, opportunity abounds. These times seem turbulent, and surely, we will have bears and bulls, and crisis and recovery. However, we may be on the cusp of a new world order that will result in more groundbreaking business leaders like Steve Jobs and Jeff Bezos and Jack Ma and Alexander Straub. It should be fun figuring out who is next…
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