October 2005
Believe it or not, the investment climate today is not all that unusual. Granted, the global economy is more integrated than ever and the U.S. economy does have some real challenges ahead. But, in the end, it's important to note that we still have to make investment decisions amid an uncertain environment. And, in a nutshell, that's what makes today pretty much the same as yesterday - investors simply have to deal with uncertainty as a part of the process.
From the war in Iraq to spiking oil prices, the housing bubble, dealing with extremely low interest rates, government deficit spending, the China threat, the outsourcing of US jobs around the world, possible bankruptcies in the auto industry, deflation worries, rising interest rates, the coming recession in 2006, hurricanes galore, the bulging trade deficit, the falling dollar, the constant threat of terrorism, inflation, stagflation, our dependence on foreign investors, the overly indebted U.S. consumer, slowing earnings growth, gas prices hitting $3 per barrel and now the possibility a worldwide avian-flu pandemic...there are a lot of worries out there.
I am sure that a few more concerns could be added to the list above and I want to make it perfectly clear that almost all of them are worth considering. But it's also clear that these concerns are already in the public domain today and, largely, it's what happens during the next 6-12 months that determines how much money you will make or lose.
Now, after reading the list of twenty-two very big worries, is it any wonder that a thoughtful investor can make any decisions with reasonable confidence? Yes, it's possible, but it does involve applying a filter and trying to focus.
The definition of a "prism" is a medium that misrepresents whatever is seen through it. Perhaps, more then ever, our media-amplified world creates this prism effect. Recognizing this and adjusting your viewpoint is where opportunities are found.
Today, any investor can earn around 4% without taking on much risk at all. Unfortunately, inflation is eating up a good amount of that return, leaving very little to spend or watch grow. Additionally, there are a number of stocks with moderate growth prospects that provide nice dividend yields and are selling for historically reasonable prices. And further, there are some ridiculously undervalued stocks that have the potential to earn investors very healthy returns - but often these involve embracing some uncertainty.
It's interesting to consider just how many variables there are to contemplate before making any investment decision. It's little wonder that most choose to just stick their head in the sand or blindly follow conventional wisdom.
Aside from the litany of worries at a high macro-economic level, making a decision on any single individual stock or bond involves making another layer of assumptions.
Bringing this idea to a more concrete level, we currently own shares in a footwear company. We're aware that they have a hot product line and we are also fully aware that most of this company's sales from this line come in during the fall and winter season. So, there's the first risk; concentrated seasonality. Now, beyond the fact that this company has been riding a real live fad (which is always a worrisome situation to invest in), we also have to consider how good of a holiday season the retail sector will turn in this year. And still again, we have to recognize the possibility that low priced knock-offs will successfully pull sales away from them. Finally, there's the simple, yet hard to analyze, possibility that they go from "hip" to distinctly "un-hip".
But the worries above are not all we have to consider. While this is just one investment in a portfolio of investments, the macro-economic environment matters too. If the U.S. housing market stops rising and consumers who are used to borrowing on their home equity line of credit pull back their spending plans, this one investment may feel an impact.
If home heating prices rise too much and the cost of driving a car inhibits free spending during Christmas, we know that this one investment will likely feel it. Everything matters - the big issues and the small company-specific issues. But the price of this stock is very, very cheap because of it all. This kind of situation literally begs us to make an investment decision one way or another.
Investors have plenty of legitimate worries and ignoring them would be considered extremely foolish. On the other hand, being paralyzed by them is equally as foolish. Peter Lynch, the famous and very successful former mutual fund manager, once said that to be a good investor is to be an optimist at the core. Almost by definition, that optimism drives you to risk money in an uncertain (yet well reasoned) situation.
I would add to Lynch's statement by saying that being a good investor almost requires an abnormal sense of optimism. You have to be a type of optimist that worries a lot about being wrong - and even then still consider yourself an optimist. To some extent, that's an odd combination.
Today's investment markets are not easy, but realistically they are never that easy. It wasn't easy in the early 80's to buy stocks when they were cheap and it wasn't easy in 1987 to hold off when they weren't. And again, in the late 90's, it was a real challenge to claim that you knew what you were doing by not buying Cisco, Yahoo and the rest.
It's likely that what makes today a struggle is in just how difficult it is to see the reality of the situation. In fact, that is precisely why today is a lot like the past. No matter what you read, it's never been that easy to make investment decisions. However, it will make it a bit easier if you try to stop seeing everything through the prism of the day.
Jason P. Tank, CFA
jason@frontstreet.com