Gil’s Musings

Investing is All About Perspective

As investors attempt to navigate choppy waters, we often come to realize how difficult it is to predict the future. Most tend to project today into tomorrow and more dangerously, we tend to act today based on what we feel about tomorrow. Investors who act on these predictive thoughts will soon be missing a few limbs. After we do this a while, we begin to recognize that the circumstances causing us angst and the felt need to navigate the turns is often just noise, and predicting tomorrow isn’t really what the game is about. The game is about maintaining perspective and staying focused on the long term. And by long term, I don’t mean this coming Friday.

With the current overload of available information often being overwhelming, we tend to retract into our own little world and think about what it all means for us. We do this to make a complicated world more applicable and digestible to our emotional selves and our need to feel good about things. Unfortunately, this behavior is in direct contradiction of both maintaining perspective, and focusing on the long term. Precisely when we need an objective view of the terrain around us, we tune out the world around us and turn inward.

This challenge is about to get a lot more difficult. The reason is that if we take our personal experience over the past twenty years or so, stocks have provided quite a roller coaster ride. An entire generation of investors now have a misplaced perspective on what risk and reward look like over time. That’s because three traumatic market events have occurred in the past twenty years, where history shows many prior twenty year periods had one such event or fewer. This means that stock returns over the past twenty years are about half of normal, and the price paid for that (volatility/trauma) is about twice normal. The chart below demonstrates the effect of our recent traumatic events compared to the long term norm.

Chart 1.JPG

This is likely to make stocks historically cheap as the disenchanted move on to greener pastures, where they will likely repeat their disappointment since they are chasing the wind.

This is actually to be expected. I wrote a musing about this same “future” concept back in 1998, when I said I was concerned that investors at that time were euphoric over a then twenty year period of returns clipping along at two-times normal. I cautioned that pain would come from that, because everything becomes average over time. The 1980s and 90s saw returns crowding 20% annually. There’s a price to be paid for that and, well here we are. The most accurate predictor of the future is “average,” and perspective is the key. The two charts below give some added perspective on the topic. See how each extended period of below-average return was followed by above-average periods?

Chart 2.JPG
Chart 3.JPG

Perspective about the current trauma could lead one to both fortunate and unfortunate conclusions. It’s unfortunate for those who get discouraged and flee since the current perceived risk/reward payoff just isn’t good enough. It’s quite fortunate for those entering or staying in the game at this point. It is precisely the discouraged exit of the downtrodden that will sweeten the pot for the rest of us. It’s like buying Meyerland real estate after the third flood in two years. Lots went for half price. “Harry, now that we’ve moved, did you hear they’re widening the bayou? Just my luck!” Beware of the information you don’t have about the future.

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