Explaining the Eclipse
FC Advisors Quarterly Investment Update – Q3 2017
The recent solar eclipse in the United States was a great opportunity to reflect on humanity’s scientific progress. It is almost impossible to watch an eclipse and not think about how people would have reacted to it if they did not understand this unique phenomenon. This of course overlooks the fact that before we had our modern understanding of astronomy, virtually every culture had an explanation for a solar eclipse. Many cultures believed some celestial beast had swallowed the sun, and they would make as much noise as possible to try to scare the beast away. According to The Atlantic, the Ojibwe tribe in the Great Lakes region believed the Sun’s fire had been extinguished and would attempt to re-ignite it by firing flaming arrows at the Sun. Since the dawn of civilization, humans have been trying to explain phenomena that impact our lives.
These mystical explanations may sound pretty silly now. Indeed in the corporate world the stereotypical manager doesn’t even have time to hear “explanations or excuses.” Yet, a staple on every financial news broadcast is a nearly constant stream of explanations for the behavior of the market. Have you ever heard the one about the Fed gods battling the inflation and deflation beasts? As much as we may think we don’t want or value explanations, we crave them when we are confronted with uncertainty. The lesson here is that when we are truly uncertain and concerned about a phenomenon, we are ready to believe virtually any plausible explanation. Reaching for the explanation that sounds & feels the best when the fear of loss (or missing out on gains) is running high often leads investors to buy high and sell low. Sadly, this means the popular case for why an asset’s price will rise sounds & feels the strongest at the top and vice versa. Our approach to counteracting this natural tendency is to always work through our sentiment & value lenses before making investment decisions. Particularly when the pressure ratchets up, it often helps us see that the sun will be shining again soon.
- The Quarter in Review
- Sentiment & Value Update
- Themes We’re Still Watching
- Socially Responsible Investing
The Quarter in Review
Both US and international stocks had another strong quarter. A spirited rally in the bond market was almost completely reversed in the last 3 weeks of September on renewed expectations of Fed rate hikes and accelerating economic growth. Markets continue to be extraordinarily focused on the possibility of US tax reform and the disposition of central bankers.
Relevant Index Performance
Total Returns as of 9/29/17
Index Qtr to Date Year to Date
S&P 500 4.32% 13.72%
MSCI World ex-US 5.69% 19.68%
MSCI Emerging Mkts 8.04% 28.14%
S&P Municipal Index 0.99% 4.28%
10 Year Treasury 0.30% 2.36%
Sentiment & Value
The chart above shows our opinion on where various markets are as of September 29th 2017. Many of the best purchase decisions are made when prices are cheap and sentiment is bearish or depressed (bottom left quadrant). Conversely, many of the best sell decisions are made when prices are expensive and sentiment is bullish or euphoric (top right quadrant).
Our cautious approach to the US stock market has yet to be rewarded. And there is no reason it has to be rewarded in the near future either. As always we approach investment and asset allocation decisions with the understanding that the market can be irrational for long periods of time. More often than not, years of strong performance that stretch valuations to extremes are followed by years of weak performance that bring valuations down to average or below average levels. We believe it is more important to make sure that our clients are prepared to buy more equity when prices fall than to try to squeeze out extra performance when the risk of a major drawdown is the highest. We will continue to gradually lean more toward bonds, and away from the most expensive equity markets. All things being equal, if the S&P 500 were to trade below 2100, we would be more comfortable buying US stocks and if the 10-year treasury yielded more than 2.75% we would be enthusiastically buying bonds.
Themes We Are Still Watching
We’ve mentioned lots of issues and themes in these letters. Just because we aren’t writing about them every quarter, does not mean we have forgotten about them. We continue to track these issues as they evolve and adjust our portfolios accordingly.
Issue: In the past 12 months the value of one Bitcoin has risen from $610 to $4,191. Some say that crypto-currencies are the wave of the future; while others say that this is a bubble just like tech stocks in the late 90s.
Impact: The total value of all the Bitcoins that have been mined to date is about $70 billion and the next 9 largest crypto-currencies are valued at about $54 billion. $124 billion is a lot of money to lose if crypto-currencies are a fad. However, $124 billion is just a tiny drop in the bucket relative to any major traditional currency.
FC Advisors Position: We don’t believe that Bitcoin is a viable global currency, but it does meet a number of growing needs. Ultimately we believe that governments will develop their own crypto-currencies to adapt to the changing needs of the global economy.
Not a viable global currency: The biggest problem with Bitcoin is that it will force deflation onto any economy that officially adopts it. The maximum amount of Bitcoin that can ever be mined is 21 million. To date 16.5 million have been mined. The current estimate of when the last Bitcoin will be mined is about 100 years from now, so the total number of Bitcoin is set to grow very slowly. The table below shows how the average number of Bitcoins per user will fall precipitously if widespread adoption were to occur.
Thus, as more people use Bitcoin, its value must rise so that one Bitcoin can buy more goods & services. The flip side of this phenomenon is that the price of goods & services in Bitcoin falls. This type of structural deflation makes borrowing money virtually impossible. With no safe way to borrow money in Bitcoin, it cannot be the primary currency for any large economy.
But, crypo-currencies aren’t going away either: Reckless money printing, capital controls, and waning trust in the global financial system in general have been like an itch that people can’t scratch. Bitcoin and other crypto-currencies are finally letting people scratch that itch. The table below highlights the relative strengths and weaknesses of crypto-currencies and traditional currencies.
Socially Responsible Investing
Issue: Increasingly investors are interested in socially responsible investing, or “Sustainable, Responsible Investing” (SRI) strategies that focus on companies that emphasize environmentally friendly, socially responsible and equitable corporate governance policies. There is a growing body of research suggesting that SRI strategies may produce superior returns.
Impact: According to The Forum for Sustainable and Responsible Investment, since 2005 the amount of money invested with an SRI mandate has ballooned from $1.5 trillion to over $4.7 trillion in 2016.
FC Advisors Position: Let’s keep the main thing, the main thing. We consider the long-term environmental impact of businesses, their impact on society and the way businesses are run as a standard part of our due diligence process. In our opinion, companies that have a net negative impact on the world are likely to be poor investments. However, we generally consider Sustainable, Responsible Investing (SRI) a marketing gimmick rather than a compelling investment strategy for two reasons.
1) The lines are blurry and subjective: There is no such thing as a perfect company and what may seem like a violation of SRI management to one person may look like a very attractive and acceptable SRI opportunity to another. MSCI has created an index “composed of U.S. companies that have positive environmental, social and governance characteristics as identified by the index provider.” This index includes several names that a strict SRI interpretation would almost certainly exclude: Nike (numerous labor violations in supplier factories), 3M (numerous pollution violations), Caterpillar (manufacturer of heavy construction equipment) and numerous oil companies such as Conoco Phillips and Marathon Oil. These blurry lines make it almost impossible for a portfolio manager to accurately predict how any given client will perceive the relative merits of any given business.
2) The impact is questionable: While management at virtually all publicly traded corporations is interested in seeing rising stock prices, a rising or falling stock price rarely impacts management’s day-to-day decision making. Why? Because, unless you are buying on the IPO or a follow-on offering, you are not giving your money directly to the company. In other words, selling your stock in an oil company does not reduce the capital available to that company – they got that money when they first issued the stock. Avoiding (or selling) a certain stock in order to send a message to management sounds & feels like a good way to make a difference. But in reality, it is the economic equivalent of shouting at an eclipse in order to scare the moon away.
Ultimately management knows that they are accountable for earnings. So if you really want to make an impact, you may want to consider ways that you can steer money away from certain companies (by avoiding their products) and toward companies and causes that you support through buying their products and giving to charities and organizations who can support the business practices and causes you endorse. That probably sounds less convenient, but making a real impact isn’t always easy!
Download PDF 2017 Q3 Investment Update
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Following Claire Advisors, LLC DBA FC Advisors is a Registered Investment Adviser. This brochure is solely for informational purposes and is not intended to provide investment advice. Advisory services are only offered to clients or prospective clients where FC Advisors and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by FC Advisors unless a client service agreement is in place.