Financial Market Observations

September 23, 2016

Litman Gregory co-founder Ken Gregory offers insight on the current investing environment and lessons learned through a range of market cycles. Watch the video.

 

Transcript

Today’s Financial Markets

It’s not been the same everywhere, but generally speaking, we’ve had very sluggish growth in the developing world, and also in the developed world.  So that’s the backdrop.

And it raises the question of, “Why is growth so weak?”

Really, there are a couple of things we can look at.  But by far, the most important is the fact that we had decades of debt-buildup and debt-expansion throughout the world.  And we’ve really hit a wall with that.

There’s a massive amount of debt out there.  And while it was being built up, it was a strong tailwind for economic growth.  It helped to fund consumption and investment.  And now it’s a headwind, which makes it more difficult to spend and invest.

Now the response to this — one of the responses — has been very aggressive monetary policy on the part of central banks around the world.  It’s really even been experimental.  And they’ve done this in order to try and nudge up inflation.  Because much of the world has been almost deflationary.  To try and stimulate economic growth, to mitigate some of the risk of large debt levels around the world, and also to promote risk-taking.

And certainly there has been more risk-taking as a result.  I mean you can look here in the US where we’ve really had a strong response to that.  And investors, when they’re faced with very low — almost no — returns from more-conservative investments like bonds and cash, are going to start making more risky investments.

And really what we’ve seen there is a very strong stock market.

So we’re really faced with an environment where what’s worked in recent years has worked not so much because the investment-case was so strong, but because of the lack of attractive alternatives.  We’ve really had a distortion of some asset prices because of this very aggressive central bank policy.  And we believe for valuation-oriented long-term prudent investors that should be a concern.

Lessons We’ve Learned from Market Cycles

Well, we have seen a lot.  You know, we’ve seen wars.  We’ve seen oil prices over $100.  Oil prices down below $10.  We’ve seen horrific bear markets.  We’ve seen normal cycles.  We’ve seen a wide range in interest rates.

When I first got into this business, rates were peaking in the mid-teens.  Now they’re negative in many parts of the world.

So there’s been a lot that’s happened.  Things coming out of left field.  And that’s just kind of a given in our business.

And the fact that markets also are very emotional.  You know?  Ultimately, there are these cycles of greed and fear, where market prices are disconnected from reality.

So all of that makes things tough.  You go through periods where you don’t feel that smart.  And I sometimes tell our people that we don’t get to look smart all the time.  Because sometimes when markets are disconnected from reality, our sort of reason-driven approach to investing may not be hitting on all cylinders.

But at the end of the day, I think the thing that we’ve learned that is so important is the importance of our discipline and really sticking to that discipline.  Because you have to be grounded in that. So when you go through those difficult periods, you don’t get tempted to do things that don’t make sense.  You don’t get tempted to pursue investments that happen to be popular right now.  Because if you do that you end up really kind of chasing your tail all the time.

And it’s really a strategy that’s been shown not to work.  Because everything’s cyclical.  These cycles run their course.  And if you’re always looking at what worked yesterday, you’re going to be missing out on what works tomorrow.

So we’re grounded in our very valuation-driven approach that relies on that fair value magnet eventually pulling investment prices back towards that fair value.  So our job is really assessing that.

Another thing that we’ve, I think, learned to have a healthy respect for is just market uncertainty.  And that’s why we use scenario analysis: to try and help us understand the range of outcomes, and inform our portfolio decisions.  Without that, it’s too easy to just really focus on one outcome.  And I think any investor that focuses on one possible outcome — one possible investment environment — is really being naïve.  Because there are so many factors that can skew one way or another that really it’s a range of outcomes that’s possible.  And that’s what we focus on.