Sir John Templeton, 1994
I moved from Colorado to Texas quite a few years ago. To the best of my recollection, highway work was clearly marked on Colorado highways as “two left lanes closed” or “right lane closed” or even “middle lanes closed ahead.” It allowed drivers the time to move into position as traffic lanes merged, allowing for a more even flow of traffic during the work hour. When I first moved to Texas, I remember traveling the highways for the first time, unfamiliar with my surroundings and coming upon highway signs that indicated “various lanes closed ahead.” I remember thinking, "What does that mean? First the left will be closed, then the right, then the middle lane? What lane should I get in? Was someone playing a joke?"
Apparently, the answer to that last question was no. It was a caution that things were about to change and I had to be ready for several possible scenarios that I might suddenly be confronted with. Ultimately, there was no way to know for certain what my position should be, but I should slow down, think clearly and be prepared for anything.
In the volatile markets we are currently facing, this got me thinking about what the signs are up ahead for investing.
Are we in a bull market or a bear market? Are you a pessimist or optimist regarding the future direction of the market? Is there reason for optimism? Is the market about to plunge on the euphoria that has driven the market to new heights? Is this a time of “maximum pessimism” and the best time to buy or is this a time of “maximum optimism” and the best time to sell? Are stocks overvalued (expensive) or cheap (undervalued). Spending five minutes on financial websites will get you articles that suit your own bias. You can, as I stated in my last article, entitled, “In Search of Treasure." I showed headlines where bears are calling for Dow 3,000 or 6,000, and bulls are calling for Dow 36,000.
In March of this year, GuruFocus’ own Geoff Gannon penned an article entitled, “Why I’m Pessimistic About Stocks” in which he articulated a comprehensive list of reasons for his pessimism. I probably should inquire as to whether Geoff is buying during the time of maximum pessimism. Perhaps, he’s not “that” pessimistic or perhaps he’s waiting for things to worsen. One of Geoff’s key points was that of recognizing his own bias, that of being bearish. His reasons for being bearish are similar to mine, but we must all recognize that our own bias can be a killer when decision-making time is upon us.
Always borrow money from a pessimist, because they really don’t expect to be paid back. — Anonymous
The advice of Sir John Templeton is wonderful advice, but investors can’t agree on optimism, pessimism, bull, bear, euphoria or anything in between. There is complete disagreement regarding the value of stocks. I can find just as many that claim stocks are undervalued as those that claim they are overvalued. So how are we to proceed in this environment? Geoff explained that his strength did not lie in macroeconomics, but as I’ve pointed out before, it really doesn’t help us that much other than to provide some caution signs in front of us. They should be flashing, “Proceed with caution.” The study of macroeconomics is interesting, but is horrible for predictive ability. The myth of economists being able to predict the future is absolute nonsense. Take it for what it is and proceed carefully. A few quick examples:
Below is a chart from the Federal Reserve which indicates housing bouncing off what appears to be a bottom and heading back up or reverting to the mean. It’s not fully recovered, but headed in the right direction. The next chart, however, indicates that home ownership is declining and has been declining steadily since 2004. How do you reconcile the two? Perhaps because hedge funds have been purchasing large quantities as rental units? Maybe. But that’s not our focus here. It’s only to illustrate how difficult decisions for investment become when you try to rely or lean on macroeconomics for guidance.
It’s the same conundrum in trying to understand why housing sales increase as mortgage rates have started to increase lately. Oftentimes, it’s because many have waited to purchase a home and now that they see rates going up, choose to act before they increase any further. At a certain point, the mortgage rate increase will cause the decline if raised far enough. But no one, including the very best economist, can tell you what that point is.
The following chart indicates the unemployment rate for the U.S. Forgetting whether you believe the numbers to be a fair evaluation of the real situation, compare the chart with the civilian labor participation chart. Once again, we are faced with a chart indicating that unemployment is or has been improving since around 2010, but the actual percentage of population that is participating in the workforce is decreasing and has been since around the year 2000. Once again, these are sometimes hard to reconcile and certainly nothing to base investment decisions on.
While it’s important to know which way the economy is headed, ultimately, the economy is not the stock market. It will never alter the value of a Coca-Cola (KO) or Apple (AAPL). It may affect it temporarily, but it doesn’t change anything within the company. Still, one cannot but be disturbed, cautious and somewhat bearish when you hear investing gurus such as Jeremy Grantham, John Hussman and many others talk about the low returns that investors should be prepared for in the decade ahead. “Caution” is the word we should be using, and we should be less concerned with “tapering” by the Fed, as many articles refer to it.
We really need a definition of maximum pessimism and maximum optimism in order to comprehend what Sir John was trying to tell us. Lauren Templeton’s book, “Investing the Templeton Way,” tells about a talk in which Sir John was specifically asked to identify the point of maximum pessimism. His response was basically that when all the sellers were gone, it was time to buy. He went on to clarify that “People are always asking me where the outlook is good, but that’s the wrong question. The right question is: 'Where is the outlook most miserable?'” In other words, when pessimism has gripped the market, we should be prepared to change lanes and take advantage while others flee.
I have bearish tendencies currently and expect a big correction in the market; however, I am ready and continuously looking for the opportunities ahead. As value investors, assuming we aren’t selling or trading every week, we should be preparing for times like this. As an example, do you like Coca-Cola (KO), but believe it’s too expensive for you? At what price would you buy it? At $38? At $35? You should establish this in advance of any correction... even if it never comes. Find the very best of the best, the stocks that you wish you bought awhile back and didn’t, and be prepared upon market pessimism to take advantage.
“But when investors don’t fear sufficiently, when they’re risk tolerant rather than risk averse – they let down their guard, surrender their discipline, accept rosy projections, enter into unwise deals, and settle for too little in the way of prospective returns and risk premiums.” — Howard Marks
“When everything’s coming your way, you’re in the wrong lane.” — Steven Wright
Disclosure: Long KO and AAPL