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Reality versus theory

Published: 
Thursday, September 20, 2012

 

October 1, 2012, is budget day in T&T. There will be many discussions pre and post the budget presentation and an exponential amount of debate and opinion to go with the discussions. Many see the annual budget exercise as having a profound impact on their lives as it impacts on people’s revenues and expenditures and therefore guides their actions going forward. Last week the US Federal Reserve met and once again there was speculation as to whether there would be another round of quantitative easing (QE3) and the impact that would have on the market. In the above circumstances, many an investor would adopt a wait-and-see approach. Since these are for all intents and purposes political events and can therefore go either way, the presumption is that the safest thing to do is to stand aside and wait and when the information is known then to determine how to proceed. This may sound like a good approach in theory, but the reality is that by standing on the sidelines and discussing what is to happen and what has happened all we are doing is debating and you don’t make money from idle talk.  Every day, week, month, year, there is some event that creates uncertainty in the financial markets. If you wait though all of it, then even if you are right, you still would be too late to the table to generate any return from being right.
 
 
Retirement clock
Assume you are 40 years old and want to retire at age 60. That leaves 20 years before you draw on your savings in the post-retirement era. Twenty years may seem like a long time, but it is really 240 months and while you sit out this month to see what comes up in the 2013 budget; next month it will be 239 months to retirement. In the last quarter of 2008, Treasury rates in T&T were around seven per cent. Today, they are at sub-one per cent. We prefer the safety, but how long would you wait until safety gives a more reasonable return? Almost 48 months of time that you would be saving towards retirement have gone by while you settle for one and two per cent rates because you are fearful.  All the while inflation makes these returns meaningless. The safety trade of today is creating a risk for tomorrow that many fail to recognise. What would happen if you do not accumulate enough resources at retirement, or that you live longer than expected, or have higher medical costs than expected? You are risk averse with your money today and hold on tightly, but those actions make it more likely that in your later years you run out of money. All you have done is defer the pain of loss 20 years.
 
 
Professional manager
There is another more measured approach. One that does not involve an all or nothing scenario and where some amount of safety is tempered by a prudent level of risk taking designed together so that you achieve your investment goals. It is about staying in the markets, remaining invested and, to a large extent, ignoring the selective cross talk that comes from the social debates. Barry Ritholtz in his Big Picture blog, summed it up best with the following: “An enormous difference exists between debating policy and managing assets. They are two radically different activities. You folks .. can .. smoke clove cigarettes, and debate this philosophically all night. That’s fun, however, that is an indulgence of the student philosopher. “Anyone who toils in the markets professionally or manages money for other people (or even their own investments) does not get to enjoy such a lavish, self-indulgent luxury. Their job is not to opine on such matters, but rather, to manage cash in the environment that is — the world that exists presently, and is likely to exist in the near future. It is not their role to manage money based on the way things ought to be — rather than the way things are.
“I think of myself as a sailor, and my job is to navigate the seas on behalf of my clients/passengers. “Any good sailor knows the seas, the prevailing tides and the lunar cycle, He understands the trade winds. He must know how to read charts, the weather, the sky and clouds. He anticipates the changing seasons. He can navigate by the stars. “A good sailor knows his boat inside and out, and can make repairs with whatever is at hand. “An experienced sailor knows when to ride out a storm, and when to turn around and head to the safety of port. “An old salt, a professional sailor, he knows when the sea is angry, when the storm gods are vengeful, where the sea monsters live. “The sailor that knows all of that, and is a little bit lucky, might return home to port alive. The rest don’t stand a chance. You can discuss the sea and the storms and the serpents all you want, but all this chatter is mere spit in the ocean. 
“Stop talking, and start sailing.”
 
 
Start investing
So while many stand on the sidelines and talk about what is happening, namely Europe in recession or, at worse, the Euro breaking apart, the US$16 trillion US debt, the slowdown in China or the reducing natural gas reserves in T&T, time is going by; 240 months is now 192. Over the last four years, you could have potentially doubled your money in the US stock market and generated significant capital gains from investing in bonds both in US and in T&T.  You may recall an article some months ago when I pointed out that ten-year US treasuries paying an interest rate of around two per cent actually generated a return of more than 30 per cent in one year. 
There have been huge runs in hard assets like gold and silver and even our much-maligned local stock market has been a top performer producing double-digit returns over the past couple years.  While all of this is taking place, the traditional safe haven of property has either hardly moved or fallen precipitously in value depending on the type of property and its location. Hopefully, this should debunk the approach of putting all of your assets into one asset class. Those that focused on the volatility, the fear, the rumour mongering, even the political malaise, have missed out on some of the best investment returns of a lifetime.  While all of this is going on, many of these same investors were happy earning sub-two per cent returns in what they presumed to be safe haven investments, not recognising the risks they were creating for themselves as the clock ticks away to retirement. Even the buy-and-hold crowd would have missed out.  
 
 
Case in point: the benchmark US index the S&P 500 closed at 1,465.81 on September 15, 2000. Last Friday, September 14, 2012, the index closed at 1,465.77; perfectly flat over 12 years. The Nasdaq, the victim of the technology bubble of the late 1990, is nowhere near its decade earlier highs. Many educated in finance but not involved in the management of investment funds have maintained the textbook notion that developed markets are efficient and so it is impossible to beat the market over time.  In an efficient market prices will reflect all available information so there is no profit to be made except from new information which is quickly absorbed into the market. All of this is fine in theory but then explain this scenario from last week. Back in June 2012, Apple announced that Facebook will be more heavily integrated into the iPhone through their new operating system iOS6. This was well known and understood in the market. Apple announced the release of iOS6 on Tuesday, the Facebook chief executive officer had a conference call on Monday, the Facebook stock was up seven per cent by Wednesday. Yet, most of what was said on either day was known months in advance.
As quoted above, “Any good sailor knows the seas, the prevailing tides and the lunar cycle, He understands the trade winds. He must know how to read charts, the weather, the sky and clouds. He anticipates the changing seasons. He can navigate by the stars.” 
The bottom line: there is a case for active management of an investment portfolio if you are dealing with a suitably qualified and experienced professional.  Stop talking and start investing.
 
Ian Narine is a broker registered with the Securities and Exchange Commission.