Mississippi Going Dry
Our periodic communication that reminds you to ask, “Should I react to those headlines?”
The Mississippi River is running dry.
“The preacher man says it’s the end of time
And the Mississippi River, she’s a goin’dry
The interest is up and the stock market’s down”
- Hank Williams Jr., “A Country Boy Can Survive”
Recent headlines have been heavily weighted toward opinions on the direction of future interest rates. Those folks who speculate on these future changes have become very popular. The number of folks participating in this game have increased as well. You may have found yourself doing it; I know I have. As our subtitle suggests, we are here to ponder if we should react to those emotional, attention-grabbing headlines, if one’s objective is to be an investor.
First off, I’d like to share some insight as to what I call “macro speculators.” These speculations take heavily leveraged positions and speculate on short-term changes in commodities, currencies, and similar items. This is a learned skill that often involves risking more than you have based on some uncertain specific future price move. The skill is in attempting not to blow yourself up just as quickly. These price changes which occur due to these macro speculators can serve as a warning system for the rest of the participants in the economy.
Our attempt to behave like investors means that we seek to avoid the urge to speculate on changes in short-term macroeconomic events. It seems as if Hank’s song from 1982 should be written today.
A few considerations as we jump in:
- CPI (the popular inflation gauge) has risen from nearly 0 to about 8%.
- Fed-controlled short-term interest rates have risen from 0 to 4%.
- Major stock markets around the world have fallen into bear market territory recently, signaling at least a 20% drop in prices.
(Finally, a word about the actual Mississippi River goin’ dry. The Mississippi was so low in November that people were treasure-hunting and making new discoveries in its riverbed!)
Here are three areas to focus on if you seek to avoid the popular speculation of the day.
First, a focus on business
Instead of speculating on macro price changes, investors focus on characteristics which make a business valuable. (We plan to dive into this topic in our next podcast.) There are four areas to assess when evaluating a business’s investment value:
- Quality: Are they doing something better?
- Speed: Are they doing something faster?
- Efficiency: Are they doing something cheaper?
- Ease: Are they making something more convenient or accessible for the consumer?
Once your analysis moves from paper to the real economy, you notice that these points become relative to the alternatives of consuming that specific business’s products or services. The business must be better than a consumer can do themselves AND better than the competitors can do it.
In some industries, the top company is well known and the price of its stock reflects that high quality except during panics and manias. Investors should be looking for these mispricing opportunities.
There are four scenarios that lead to possible attractive purchase prices for owning great businesses:
- General manias and panics
- Oversupply from heavily levered, lesser-quality competitors that causes an industry glut and temporarily lowers profit margins
- A specific event that has brought complexity and uncertainty to the industry or business
- Undiscovered innovators that are disrupting bloated leaders
Yes, as Warren says, “It’s simple, but not easy.”
Second, a focus on long-term trends
A macro speculator depends on sudden price moves to profit. Focusing instead on the long term as investors is the smarter option because speculating certainly leads to financial disaster or even ruin. Yes, a minority of speculators will make large sums, maybe even becoming famous. But a lot will go broke (some of those also famously so), and most will simply not keep pace with long term investors. At best, speculation is an unproductive waste of their time over long periods; at worst, many will go broke quickly and cause financial pain to all those around them.
These are some examples of attention-grabbing headline questions that depend on speculation:
Will oil spike?
Will the dollar fall?
Will inflation drop?
Will interest rates drop?
Will the war become worse?
Will the Dow fall?
Will Europe fall?
Will Japan fall?
Conversely, investors can position themselves for long-term trends. In considering such, the GDP of democratic countries with private property rights and rule of law have improved over time, despite the many “financial preachers’” calls of the end times. This improvement in GDP occurs in an unpredictable fashion. This boring reality proves difficult to move people to action. Instead, media and others needing our attention, attempt to spice it up by speculating, gambling, and forecasting large events like the end times.
Finally, a focus on your own expectations
It is very easy to be swayed by the media and popular opinions of the day. When you find yourself with expectations for the long-run performance of your investments at odds with long-term historical norms, it is likely that you have fallen under the spell of the pied piper. We wrote a “Dis and Dat” about this topic in August 2021, Returning to Earth | Advisor.Investments.
These are some other thoughts about setting reasonable expectations from investing.
An investor reviewing their results may find that even with all the care taken on business selection, some of the investments will perform horribly (maybe even going to zero), a lot will be mediocre, and a few will compound amazingly, more than making up for the other two categories.
All this uncertainty calls for risk management. Poor performance of any single investment should never become a danger to your overall financial security, which would force you to become a macro speculator. The investor will want savings that aren’t invested as part of their risk management strategy, a low and steady withdrawal rate, and diverse risk drivers across multiple positions.
On the other hand, when an investor does not put enough money into their winning investment ideas or they do not hold onto winners long enough, they end up with returns closer to returns that savers will earn. This low return usually becomes frustrating and at some point, and they are forced into gambling and speculating to “catch up.”
For an investor, what is avoided becomes more important than predicting a short-term change in some macro event. The investor will need to avoid overhyped investments and low-quality businesses.
This Alan Watts quote about life in general seems to provide an understanding of why the stories of macro troubles catch our attention:
To pursue (the future) is to pursue a constantly retreating phantom, and the faster you chase it, the faster it runs ahead. This is why all affairs of civilization are rushed, why hardly anyone enjoys what he has, and is forever seeking more and more. Happiness, then, will consist, not of solid and substantial realities, but of such abstract and superficial things as promises, hopes, and assurances.
Thus the “brainy” economy designed to produce this happiness is a fantastic vicious circle which must either manufacture more and more pleasures or collapse-providing a constant titillation of the ears, eyes, and nerve ends with incessant streams of almost inescapable noise and visual distractions.
This leads me to ponder that maybe the good investors have a simplicity much like Hanks’ Country Boy, and leave the macro speculation to those fancy types.
Thanks for your attention, I hope this helps, and please be safe,
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