“The Only Thing That Is Constant Is Change.” - Heraclitus
I plan on keeping this monthly outlook shorter than usual, as the past few weeks have been busy. Not the good kind of busy, mind you, but the kind that has my nose buried deep in what seems to be an endless pile of paperwork. The reason for this is that our relationship with Protected Investors of America, the firm that served as our broker dealer and registered investment advisor has come to an end. The structure of PIA has changed and advisors have now affiliated with Cambridge Investment Research - and so, along with the multiple benefits and resources that accompany this transfer over to Cambridge, I also find myself experiencing the familiar hurt of navigating a new system and the processes that go with it. C’est la vie – This is life.
Adapt or perish is also a popular saying. This phrase was ringing through my head on a recent evening commute home, as I sat on the freeway in bumper-to-bumper traffic just a few miles shy of my exit. Playing out like a tragic comedy, I noticed the same scenario repeat itself over and over again. One of the lanes started to move just a little faster than the rest, and soon enough multiple cars began jockeying for position looking to make the switch into the “fast lane.” Within seconds however, the “fast lane” had come to a standstill, as it was now overcrowded with additional cars, making it the slowest lane. The drill is familiar, yet many of us are suckered into this behavior from time to time. It is the same everywhere regardless of where you live - rinse and repeat.
One might ask, how is this story relevant? My focus has to do with human behavior and the similarities I see that occur regularly in financial markets. Whether we are talking about a stock, bond, currency, commodity or whatever – it really doesn’t matter. What matters is that when everyone starts buying or selling the same thing, be it an underlying financial instrument or a financial strategy, it is likely that any excess returns will be squeezed out fairly quickly and many investors will be left with losses, or at a minimum underperformance. Investors must also adapt or perish. The way I see it, those investors who view technology as the holy grail of investing and robo-advisors as their savior will likely be in for a rude awakening, as the academic models used to construct portfolios are based on relationships between variables (known as covariance in statistical jargon) which utilize historical data that by their nature are constantly changing in inexplicable ways. In my experience, the models fail when they are needed most, for the simple reason that everyone has piled into them. Or said another way, all the cars are lined up in the same lane hoping to go faster than their peers, but have not realized that they are all employing the same crowded strategy.
James Grant, the well know financial market analyst and author of Grant’s Interest Rate Observer was recently quoted on the investing website valuewalk.com. He had this to say in relation. “Even in the age of computers and algorithmic systems increasingly pushing price activity, markets are driven by emotions. To assume that a stock’s value is derived from nothing other than corporate earnings discounted by the prevailing interest and tax rates is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin and believed Orson Welles when he told them... ‘Martians had landed.’ In the end markets are as efficient as human emotions, which is why at times both can be very volatile.” Humans frequently act in crazy, irrational, unpredictable ways, and this is why I believe automated investing based on algorithms geared to the masses will not produce the desired results. It has not worked in the past and it will not work in the future.
On markets, my thoughts have not shifted and are pretty much the same as they have been. I think prices for the most part are going up, and expectheightened volatility to persist. In a world of zero to negative interest rates global stocks can go higher despite convincing arguments related to stretched valuations. U.S. Treasuries will likely stay bid as global money seeks both safety and positive yielding returns, while the U.S. dollar also appears attractive on a relative basis, even when considering a Fed on hold scenario. I believe gold could also continue to shine brightly (Figure 1). It is likely that we will not fully understand the consequences of NIRP (Negative Interest Rate Policy) until it is too late, but let's agree for the time being to shelve that discussion for another day in the future. In the meantime the music keeps playing and investors keep dancing. This is truly unprecedented
Sincerely,
Justin Kobe, CFA Founder & Portfolio Manager
Advisory services through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Cambridge and Pacificus Capital Management are not affiliated.Material discussed is meant for general illustration and/or informational purposes only, and it is not to be construed as investment, tax, or legal advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice. These are the opinions of Justin Kobe and not necessarily those of Cambridge Investment Research, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Investing in the bond marketis subject to risks, including market, interest rate, issuer credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies is impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Diversification and asset allocation strategies do not assure profit or protect against loss.