(Ed Note: Vern Gowdie’s new publication, Gowdie Family Wealth, will be launching early next week. Watch this space for more info.)
‘Do not fear to be eccentric in opinion, for every opinion now accepted was once eccentric.’ – British philosopher & mathematician Bertrand Russell.
Questioning convention can be both challenging and lonely. Going with the flow of popular thinking is far easier.
The problem with popular thinking is it doesn’t require you to think at all. You just nod and agree with the thinking of the day.
The ability to shape popular thinking is why the investment industry spends so much time and money on its pet project – how to attract more funds to manage.
The basic marketing strategy revolves around enough experts repeating the same message (couched with a slight difference to avoid absolute repetition) until it becomes popular thinking – hey presto they have created a truism.
Two examples of this messaging are:
- In the long term shares always go up(…unless of course you are a Japanese share investor circa 1990)
- Cash is trash (…unless of course you were cashed up prior to the GFC)
The industry designs these marketing messages (one positive and one negative) to generate interest in the industry’s products.
Don’t Underestimate Safety
The message can come in a variety of forms. One such message was in the Weekend Australian (August 10-11 edition) under an article titled ‘Where to go, now cash doesn’t cut it‘.
From the headline it’s not hard to guess which theme was at play; ‘Cash is Trash’.
Here is an extract from the article (emphasis added): ‘Mr Bell [from Goldman Sachs Asset Management] makes it clear the picture is a bleak one for investors who are still sitting on big cash positions …‘
My question is, ‘Why is the picture bleak?’
The mainstream response would be, ‘Well interest rates are falling (and expected to fall even further) and your after tax rate of return is barely keeping pace with inflation.’
OK, I accept money in the bank is slowly having its buying power eroded. But on the scale of bleakness, what is worse?
- Slow erosion (maybe 1% per annum) of buying power as you wait for an opportunity to buy assets at significantly discounted prices OR
- Rapid erosion of your buying power due to the very real possibility of a market correction wiping 50% or more off your capital.
The fact the article didn’t canvass these possibilities goes to the heart of the industry’s unshakeable belief in the share market being everyone’s best friend…albeit with the occasional bad mood.
The article went on to say:
‘Mr. Bell runs the Goldman Sachs Income Plus Wholesale Fund… Its one-year performance number is what catches the attention: 10.1 per cent for the year to May 31, of which 6.6 per cent was capital growth and 3.5 per cent was “distribution return” or dividends.‘
This is indeed an excellent result for the 12 month period ended 31 May 2013. However when you look at the performance of the fund since inception (May 1998), its 15 year annual return has averaged 6.5% (sourced from Goldman Sachs website).
Based on the established math principle of ‘reversion to the mean’, it’s not unreasonable to expect the strong performance of the past 12 months to be counterbalanced by a corresponding period of lower returns. This is simply the ‘yin and yang’ of markets.
In fairness to Mr Bell he didn’t write the article and while I don’t know him personally, the fact he works for the blue-chip Goldman Sachs means he has excellent credentials.
The point I’m making is the use of one-year figures can distort the bigger picture and create confusion in the minds of the average investor searching for direction.
I could equally quote the one-year cash rate of 2008/09 (GFC year) to trumpet the merits of cash against other asset classes. This too would be an unfair comparison.
The reason for my portfolio position being in cash and term deposits has very little to do with ‘bleak returns’ and everything to do with capital security. Biding your time waiting for assets to fall to much lower levels is a genuine investment strategy.
The investment industry may believe the market levitation act being performed by central bankers (using ZIRP and the printing presses), but I don’t. Therefore it means employing a different investment strategy – one that is at odds with popular thinking.
Another ‘truism’ that’s generally accepted by the public is the concept of risk/reward. The popular thinking is that if you accept a higher risk somehow this will equate to a higher return. Wrong.
Stay Cashed Up for the Coming Bargains
One of the highest risks you can take is to buy into an over-priced market – ask anyone who invested in the NASDAQ in early 2000 (the height of the tech boom). Thirteen years later they are still down 20% in value.
The best risk/reward equation is low risk/high reward.
Money in the bank at present is a no risk (to capital value)/low reward proposition.
Share markets, in my opinion, are a high risk/low reward proposition.
The current P/E of the S&P 500 (based on Shiller P/E 10 model) is 23.8x.
This is 50% above its 130-year mean of 16.5x.
The periods when the share market offers low risk/high reward are when the P/E falls below the mean (and even better if it’s sub 10x).
Since the GFC the global share market (led by the US) has been manipulated more than a ‘Punch and Judy’ show.
The market cannot stand on its own two feet without the central banks pulling on the strings of ZIRP and QE to Infinity.
When these strings snap (and they will) the P/E mean of 16.5x on the Shiller P/E model will be nothing more than a whistle stop.
As the Great Credit Contraction continues to squeeze the global economy, I fully expect the cash rate to fall even further – perhaps into the mid-1′s. Sure this is bleak, but not nearly as bleak as the outlook for the global economy that forced the RBA to plumb to these lows.
This global contraction process will eventually expose the central bank puppeteers, and markets will respond accordingly. When this happens, cashed up investors will find that a dollar in the bank has a whole lot more buying power.
This view isn’t popular in the mainstream, but I hope it has been thought provoking for you.
Vern Gowdie
Editor, Gowdie Family Wealth
From the Archives…
How Many Warren Buffett’s in a Bar of Gold?
16-08-2013 – Kris Sayce
Two Points to Consider from the Commonwealth Bank…
15-08-2013 – Kris Sayce
Take Control of Your Superannuation, but Know the Limits
14-08-2013 – Vern Gowdie
Why I’m Glad I Missed a Dividend Stock That Doubled…
13-08-2013 – Kris Sayce
No Profit in the Federal Reserve Divination
12-08-2013 – Dan Denning
