Beauty contest / ugly tree

“Professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole: so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgement, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees.”

• John Maynard Keynes, The General Theory of Employment, Interest and Money, 1936.

“Stocks fell out of the ugly tree and hit every branch on the way down.”

“Dr. Ross Jennings : Chris, I’m scared to death [of spiders].

Collins : Yeah, we all are, but our brains secrete a neurotransmitter that enables us to deal with them.

Dr. Ross Jennings : I don’t think I have that particular neurotransmitter.”

• From Frank Marshall’s Arachnophobia, 1990, screenplay by Don Jakoby and Wesley Strick.

“Everyone has a plan until they get punched in the mouth.”

• Mike Tyson.

William Goldman began his 1982 account of life in Hollywood, Adventures in the Screen Trade, with three words:

Nobody knows anything.

What holds in the movie business also holds for investors in the early stages of a global pandemic that nobody, other than perhaps Dominic Cummings, foresaw. Regardless of whether Wuhan Flu developed in a bioweapons facility or on the back of Chinese diners gobbling bat soup or pangolin on toast, the world is stuck with it and administrations are scrambling to get ahead of it. [Readers seeking some light relief from the news cycle may appreciate this utterly unrelated piece via Twitter about Barry’s chocolate biscuit.]

Decision-making under conditions of the purest uncertainty is never easy. Perhaps most investors are like Keynes’ beauty contest judges – reflexively tying themselves in endless recursive knots trying to anticipate the choices of others. Should equity investors sell, acknowledging the anticipated fear of others, in the hope of buying back more cheaply at a later date ? Perhaps. But we do remember the market environment of early 2009. March 2009 – with hindsight – represented the great secular opportunity to go long equities; perhaps the greatest in a generation. The minor problem was that at the time, it felt like the world was going to end. Our point ? Market-timing is tricky enough under generally benign macro-economic conditions. In a world struggling to see through the shorter term noise over the new coronavirus, it is surely impossible. So our somewhat resigned conclusion is to refocus, as ever, on valuations on a bottom-up basis, and to maintain broad diversification which includes meaningful exposure to portfolio (and crisis) hedges such as precious metals. We will, in other words, never be bullied entirely out of the stock market because we’d never know precisely when it was an appropriate time to get back in. Words you rarely hear fund managers say: we just don’t know.

That said, we see a deal of good sense in Anton Tonev’s thoughts in Beyond Overton:

As if rates going negative was not enough of a wake-up call that what we are dealing with is something else, something which no one alive has experienced: a build-up of private debt and inequality of extraordinary proportions which completely clogs the monetary transmission as well as the income generation mechanism. And no, classical fiscal policy is not going to be a solution either – as if years of Japan trying and failing was not obvious enough either.

But the most pathetic thing is that we are now going to fight a pandemic virus with the same tools which have so far totally failed to revive our economies. If the latter was indeed a failure, this virus episode is going to be a fiasco. If no growth could be ‘forgiven’, ‘dead bodies’ borders on criminal.

Here is why. The narrative that we are soon going to reach a peak in infections in the West following a similar pattern in China is based on the wrong interpretation of the data, and if we do not change our attitude, the virus will overwhelm us. China managed to contain the infectious spread precisely and exclusively because of the hyper-restrictive measures that were applied there. Not because of the (warm) weather, and not because of any intrinsic features of the virus itself, and not because it provided any extraordinary liquidity (it did not), and not because it cut rates (it actually did, but only by 10bps). In short, the R0 in China was dragged down by force. Only Italy in the West is actually taking such draconian measures to fight the virus..

The Coronavirus only reinforces what is primarily shaping to be a US equity crisis, at its worst, because of the forces (high valuation, passive, ETF, short vol., etc.) which were in place even before. This is unlikely to morph into a credit crisis because of policy support.

Therefore, if you have to place your bet on a short, it would be equities over credit. My point is not that credit will be immune but that if the crisis evolves further, it will be more like dotcom than GFC. Credit and equity crises follow each other: dotcom was preceded by S&L and followed by GFC.

And from an economics standpoint, the corona virus is, equally, only reinforcing the de-globalization trend which, one could say, started with the decision to brexit in 2016. The two decades of globalization, beginning with China’s WTO acceptance in 2001, were beneficial to the USD especially against EM, and US equities overall. Ironically, globalization has not been that kind to commodity prices partially because of the strong dollar post 2008, but also because of the strong disinflationary trend which has persisted throughout.

So, if all this is about to reverse and the Coronavirus was just the feather that finally broke globalization’s back, then it stands to reason to bet on the next cycle being the opposite of what we had so far: weaker USD, higher inflation, higher commodities, US equities underperformance.

That’s my playbook.

It is kind of our playbook too, albeit we’re not shorting anything (although our systematic trend-following managers surely are – or at least will be, soon). We have no strong view on the dollar, but we do foresee higher inflation on the back of a presumed fiscal response to the crisis by desperate governments suddenly gifted a budgetary ‘get out of jail free’ spend-spend-spend card by the pandemic. We don’t consider equity market exposure in terms of geographic underweights or overweights, because we’re not benchmarked to indices. Our only reference rate is one of absolute return. And we only invest where we see compelling underlying value, and right now those opportunities simply tend to be in Asia, or outside the US.

Why good investments are not a casino – the price history of Seaboard Corporation, 1995 – 2019

Source: Bloomberg LLP

But not all of them. One of our favourite equity investments is Seaboard Corporation, a globally diversified agribusiness, managed by the Boston-based Bresky family. The fact that it is family-run is one reason we like it. The fact that the Bresky family have proven themselves over the years to be superb capital allocators is one reason we like it. The fact that it is covered by precisely zero Wall Street analysts is one reason we like it.

The chart above shows three lines. The purple line shows the trajectory of the S&P 500 stock index. Over the past 24 years the index has delivered 534%. Not too shabby.

The white line shows the share price of Seaboard Corporation. Some 1583% over the same period. Also not too shabby – but clearly volatile.

Arguably the most important line on the charts, however, is neither the purple line nor the white line, but the green line – which denotes the book value per share of Seaboard stock. Note that whereas the white line (share price) is all over the place, the green line (book value per share) is reassuringly stable, albeit trending higher over time.

Conclusions:

1. As Mrs Beeton might once have remarked, first, find your Seaboard.
2. Note that, over time, book value per share highly correlates to the share price (or vice versa).
3. There are times when the share price trades close to, or sometimes even below, book value.
4. Those such times are called buying opportunities.

So the stock market isn’t a casino – or rather, it doesn’t have to be. It doesn’t have to be if you can focus selectively and opportunistically on real value, as opposed to anticipating the emotional responses / beauty contest choices of others. After that, you just have to be patient. And also, in looking through the fear and short term uncertainty to the recovery beyond, perhaps a little brave. Prudent stock selection – driven by maths, and not by hope or fear – and genuine asset class diversification should carry you the rest of the way.