Learning to Live With Volatility

Learning to Live with Volatility

Market volatility has become a fact with which investors have had to learn to contend. In Jack Bogle's just published book, The Clash of the Cultures: Investment vs. Speculation,* he draws a sharp demarcation between speculators and investors; given today's volatile financial markets, an important distinction. As we know, today more than 60% of the daily stock market volume is super-computer-based, high frequency trading with "hunter-killer-algobot" financial models seeking minute anomalies (speculation by another label); Jack's message is right on point.

In a note to me accompanying a pre-publication copy of the book, Jack summarizes the essential argument he is attempting to persuade his reader and investors (individual as well as professional) to consider:

" . . . (our) philosophy was importantly shaped by the idiocy of the "Go-Go" era to our own great benefit and that of those we (may) have influenced. Still, as it will always be as long as each trade has both a buyer and seller, A's dumb behavior is balanced by B's smarter behavior, something that so many . . ." seem unaware. The "Go-Go" era Jack refers to was the frenzied 1971-1972 period of the so-called Nifty-Fifty growth stocks; a mania when IBM, Avon products, Proctor & Gamble, etc. (i.e., the fifty largest U.S. corporations) were all selling at valuation multiples in excess of 40x prospective earnings, and Wall Street brokers promised that a portfolio of these holdings alone was a ticket to perpetual wealth creation.

In The Clash of the Cultures, Jack suggests ". . . 10 elements of a simple strategy that should help . . ." A few are doubly appropriate today:

2. Time Is Your Friend; Impulse Is Your Enemy
3. Forget the Needle, Buy the Haystack
8. Beware of Fighting the Last War
9. The Hedgehog Bests the Fox

Selectively, of course, these aphorisms support the guiding philosophy behind our portfolio management approach. By Rule #9, in particular, one interpretation would be that rather than continually attempting to find the yellow brick road down which a smarter-than-the-market, wily "expert" might promise to take you, building a global portfolio aimed at capturing the world's equity markets' returns (with careful attention to the level of overall portfolio risk assumed) should be the application.

A Pundit's Peril, An Editor's Dilemma, A Syndicated Columnist's Delight

"Darkening Clouds," "Uncertainty about European Crisis and Forthcoming U.S. Elections," "Soft Patch of Manufacturing Output," "Disquieting Sluggish Growth," "New Misery Index Highs": they are at it again . . . in a single day's edition of the Wall Street Journal recently, on one page this string of descriptive phrases characterizing today's financial markets unloaded on its readers a crescendo of concern about the outlook.

Not that there aren't more than enough critical issues facing investors at the moment. But perhaps a more interesting question one might ask would be . . . With all these concerns, what's supporting global equity markets at these levels? True, there is a plethora of central bank-generated cash floating about the banking system and interest rates remain at all-time lows. But the short answer, in our view, is that equities today are more attractive relative to bonds than has been the case since WWII. Stock dividend yields exceed high quality U.S. Treasury coupon yields and stock price-to-earnings ratios remain reasonably valued. There is much to be concerned about, but fundamental relative investment values favor a continued equity overweight over the intermediate term.

The Longer View

During the past few years, these client notes have raised the possibility that the U.S. may be moving towards greater energy self-sufficiency, a development which could have lasting competitive advantages in global economic terms. As this story continues to play out, and the abundance of our natural gas resources becomes more evident, the implications for environmental improvement are also beginning to draw attention.

The science remains inexact to say the least, but the effect of substituting cleaner, cheaper, natural gas in the generation of electricity alone seems to have caught climatologists off guard. For example, it appears that total U.S. carbon emissions from energy consumption which peaked in 2007 are now back down to nearly 1990 levels.** Not only is this closing in on Kyoto Treaty goals (the U.S. now accounts for only 16% of the world's carbon emissions), but it should put China (29% of global carbon emissions) squarely in the cross hairs of environmentalists. Of interest will be how our political class attempts to shape the discussion around this emerging reality, as well as how it plays out on the international geopolitical stage.

Should you have any questions or comments, please let us know.

Best,

James L. Joslin
Chairman, CEO & CCO

*Bogle, John C., The Clash of the Cultures: Investment vs. Speculation, John Wiley & Sons Inc., 2012.

**U.S. Energy Agency Report, U.S. Federal Energy Department