Christmas Communications: How I Advised My Clients Through a Tumultuous 2016

I often find reading client letters and something I found strikingly common was just how transient conclusions are – even seemingly momentous, life-altering ones; those reached with a high degree of conviction at the time. One month removed and the angst of it all is banished to the far recesses of the mind: Worries over what could happen if Britain voted to leave the European Union, or global-growth fears in the first quarter, now seem small with U.S. stocks flirting again with record levels.

As we look ahead to 2017 and the new set of challenges it brings, it’s helpful to look back on the hurdles we cleared this year. Below, I have sewn together bits and pieces of real and living investment questions I have received from people whose financial property I am entrusted, and my answers to help guide them in the right direction.

Q: Should I set up a speculative day-trading account?

A: There is absolutely nothing wrong with trading markets if that’s what you love doing and it’s what you are good at.  But the evidence plainly shows that the great majority of us are not.  Worse yet is the vast majority of those people who think they are good at it are not either and they will be competing against people who are better and have much deeper pockets.

Think long, hard, and honestly about what your scope of competence actually is before setting up a day-trading account.

Q: How do I protect against risks including market timing, the knowns and the unknowable about investing in financial markets.

I keep an adequate margin of safety against the unknown and unknowable rather than risking capital in a vain attempt to predict it.  When it comes to financial markets and “what if” scenarios, just because I cannot predict something will happen doesn’t mean I should act as though it won’t happen.

Q: A big, unexpected risk event – like Brexit or the U.S. election – just happened. I’m panicked about losing all my investments – what should I do?

These market events are clearly unsettling but do bear in mind that perceived uncertainty causes great emotional discomfort which is never favorable to good decision making. There is no doubt that worst case can be a lot worse than we have ever seen before – that is precisely why you have a 20% allocation to managed futures – an asset class that has clearly demonstrated negative correlation in market stress!

A deeply diversified investment portfolio shields long-term investors since, as we know, forecasting tomorrow or next week is foolish as compared to understanding value.

Try to embrace the current volatility – understand the market might price it (i.e. Brexit, U.S. election) for a while whether it ultimately happens or not.

Q: Should I be worried about a hyperinflation situation and how it impacts my portolio?

According to history, inflation seems to be a phenomenon of sorts.  From ancient Rome to Ming China to 18th Century America – you will learn that wild bouts of inflation are typically caused by overleveraged governments as a way to avoid government default.

It is true that we are in the midst of a world-wide monetary policy experiment that has never been attempted and while central bank track records are historically dismal – we really have no idea how it will all end up.

I do know that nothing moves itself – everything that is moved, including quantitative easing, must be moved by another.  In short, we do not know who will pay for this experiment but eventually something or someone will pay.

Q: A financial guru on TV talked up this hot stock and said it will go straight up and could make me a lot of money – what do you think about it?   

Our financial culture has ebbed to new lows where we now perceive expert market prediction out as an equivalent to knowledge and that the knowledge gleaned is somehow objective.  This is an illusion!  The idea that there is a kind of knowledge that is not dependent on subjectivity – bias, slant, emotion – is a powerful and dominant notion in our financial culture, but it is woefully absurd!

Q: My favorite S&P sectors – health care and consumer staples – vastly underperformed a well-diversified portfolio this year! I thought they would be the keys to make me rich this year!

In 2016, If only I could have had all my clients overly-concentrated in S&P energy stocks (+25%) or financials (+22%) yet that is not the game I play nor is it what I wish for my clients.  Three decades of experience have shown me that risk is not static – it is always changing.  Personal market timing or sector rotation depends on what occurs on average.  What they do not tell you is markets don’t care to operate on averages.

Q: What’s up with the spike in Treasury bond yields? What did I miss?

Interest rates have definitely spiked from their mid-summer lows however, bear in mind, on a year-to-date basis, two-year yields are only up 0.13 percentage point, while 10-year yields are up 0.28 percentage point, and 30-year yields are up 0.12 percentage point.  From a year-to-date perspective, the yield spike doesn’t seem as intimidating. There exists a myriad of potential explanations for higher yields:

• The market believes economic growth will be higher and thus investors can get superior returns in other investments.
• Investors perceive a world that has more risk and thus are requiring a higher interest rate against the perceived credit-worthiness of the issuing country.
• Consensus assumes an imminent bout of inflation and thus a steepening of the interest rate yield curve.
• Global government monetary intervention has become blasé.  Governments have been the largest buyers of debt and have been responsible for keeping rates ultra-low.  The slow removal of a buyer will allow rates to flow more naturally.

The bottom line is that even if we had the inside scoop to the U.S Federal Reserve’s exact interest rate moves three years ago in advance it still would not have mattered much.