“The day is not far off when the economic problem will take the back seat where it belongs, and the arena of the heart and the head will be occupied or reoccupied, by our real problems — the problems of life and of human relations, of creation and behavior and religion.”
– John Maynard Keynes, First Annual Report of the Arts Council (1945-1946)
When Keynes expressed his thoughts in 1946, the world was beginning to recover from World War II and the Great Depression of the 1930s. As we cross the midpoint of 2016, the market is again staring into the dark, looking for a few sparks of global economic growth to light its path. In many ways, this is more than just a redux of the double-dip recession fears we waded through during 2010 and 2011.
We now have several things to add to the list of all that is scary, disruptive or dislodging, or the worst of all prognostications: boring and slow. China’s economy has noticeably slowed, and commodities have responded. Global interest rates have softened meaningfully, and the interest rate on the debt of some countries has converged towards zero or even negative levels. Great Britain is dealing with how to handle its porous borders by threatening to leave the European Union altogether. Domestically, rhetoric has increased about the new economy leaving the old economy in the dust – again (remember 1999?). The hope of higher interest rates becoming a tailwind to earnings for banks looks temporarily shattered, while lending activity remains tepid. Add the political season to the mix, and we’ve got quite a game right now.
Much of this has little or no direct relevancy to the fundamentals of the individual companies we own. Similar to other times of macroeconomic myopia, we view today’s version largely as an exhibition of noise, albeit at increased levels. In a market greatly affected by psychology, especially the fragile type, perception is indeed reality. And fragile psychology is exactly where we’re at today, if the votes tallied from individual investors who participate in investing clubs are any indication. Recent readings have given us the least bullish sentiment than any time over the prior 10 years, including the 2008/2009 economic Armageddon we lived through.
So where do you go if you want to make money in the stock market, yet approach it with a frangible psyche? You look for a trade and don’t invest at all. Instead, you look to buy something that may be beaten up in price, perhaps appears to have reached a capitulatory point, and take a position. What got beaten up the most as the market reached its yearly low on February 11th? It’s been cyclical, debt-laden companies that are generally low quality price-takers. These bottom of the barrel common stocks are exactly what has accounted for the market rebound through the second quarter. The chart below shows that low-quality has beaten high-quality by nearly 12% from the intra-year market low. Cyclical companies have beaten defensive stocks by more than 9% over that same period:1
We’re always on the hunt for companies that have a propensity to be multi-year compounders of wealth. To do that, we need to own them over long periods of time. This includes times like today, when the market has a fondness for betting on statistical probabilities rather than investing in high quality companies that generate attractive and consistent levels of profitability and cash flow.
We love the quote from John Maynard Keynes, reminding us that these periods of fixation on macroeconomic problems will pass. At a minimum, they will be replaced with new issues for obsession. But throughout these rotations, Keynes reminds us that the problem of life and human relations will persist! We have some more modern economic commentary that seems to nail this phenomenon on the head, credit to Ms. Spade and Ms. Derek:
“Playing dress-up begins at age five and never truly ends.” ―Kate Spade
“Whoever said that money can’t buy happiness, simply didn’t know where to go shopping.” ―Bo Derek