Successful investing is not a study of certainty, but a value judgement based on probable outcomes. The US electorate has voted and the result is contested, but what this means for the US and global economy is still uncertain. A US election is important because the US accounts for 25% of global gross domestic product (GDP) and the US dollar is 75% of all world trade, with the US 10 year Treasury Bond being the global benchmark for credit and the US dollar the world’s reserve currency.
According to Warren Buffett, the art of successful investing at its most fundamental is perhaps best illustrated by one of Aesop’s fables. Written circa 600 BC, the fable concludes that ‘a bird in the hand is worth two in the bush’. In the context of investing, the ‘bird in the hand’ is the prevailing interest rate, and the ‘two in the bush’ is the potential growth of capital over time. What Aesop did not know was the interest rate, how many birds there would be in the bush and how long they would be there.
Buffet said that investing is laying out money now to get more later on. A bond tells you how much you will get back in interest and principal. Not so when buying an equity share in a business. When committing capital, you have to determine whether it will pay out more cash, giving you a greater return on your capital at some time in the future than holding cash today. What is the probability of outcomes in regard to return on capital allocated? This requires analysis. Buying a stock or index because the price is rising, or selling because you feel the price will decline, is gambling.
In spite of all the economic uncertainty as a result of the pandemic and the political response, we know that during the next decade we will encounter disinflation (pressure for prices to fall), deflation (prices falling), stagflation (rising inflation and unemployment, low growth) or inflation (rising prices), but we don’t know for how long, or in which order.
In my view, the probability in the short term is an increase in deflationary pressure followed by inflation. The real challenge for investors is deciding how to allocate capital to preserve the purchasing power of money when the main four central banks are engaged in competitive devaluation (deliberately devaluing currency) during the next decade.
According to Benjamin Graham, the market in the short term is a voting machine and in the long term a weighing machine. Bull markets (rising prices) beget bear markets (falling prices), which beget bull markets. There is an inevitability about the movement of market prices over the long term, which reflects human nature.
In times of heightened uncertainty, attempting to outsmart the market (and therefore all other investors) by selling or buying in anticipation of a sharp movement in market prices will usually fail to reward the investor. No one can time the market successfully, nor does anyone know someone who can!
Short-term outcomes will always be uncertain. It is over the long term that a correct value judgement based on the probability of investment outcomes becomes more certain, and may reward the diligent and patient investor.
Jeremy Blatch TEP