Conviction Investing is a Lonely Place

Last Saturday night my wife and I went to a local cafe. We struck up a conversation with the younger couple (in their early 30s) sitting next to us.

The young lady was in real estate and her partner in the construction industry. From 2008 to 2013/14, the Gold Coast was a graveyard for the property industry. In the past 12–18 months, the real estate sector has recovered some of its mojo. It was clear the pickup in the sector gave the couple a degree of optimism about their future financial prospects.

My natural curiosity obliged me to ask the young lady her opinion on the local property market:

Young lady: ‘Going to be strong through to 2018.

Me (somewhat amazed at such a bold 3-year prediction): ‘Why?

Young lady: ‘All the construction that’s happening for the Commonwealth Games.

Me: ‘What happens if a global event like a bank in China fails, surely the Gold Coast property market won’t act in isolation to this type of event?

Young lady looked at me perplexed. Time to change subject.

Me: ‘So do you have any photos of your daughter?

Knowing what the public is thinking is an essential component to successful investing. My straw poll (of friends, strangers, businesspeople) tells me people are (generally) quietly optimistic.

No-one is talking boom times, but by the same token no-one is contemplating another GFC (or worse) type of event.

The central bankers have done an excellent job of calming troubled waters. The cost for this sedation is measured in trillions of dollars/yen/euro/renminbi/pounds, but it’s worked…so far.

Headlines of collapsing share markets, countries declaring insolvency, bank runs, corporate bankruptcies etc. are not exactly uplifting for social mood.

When you consider the fact that the entire global economy runs on that precious commodity of confidence, you understand why the central bankers have been prepared to do ‘whatever it takes’. To the central bankers, the real horror of a collapsing global economy and financial system is not the hardship society would be forced to endure. No, the truly great horror for them would be their irrelevance and the repudiation of their academic theories. With no levers to pull and much anticipated announcements to make, they become sad and lonely figures — much like Michael Corleone in the final scene of Godfather III.

From my many conversations (with non-geeky financial types), the macro view of the world is one they are largely oblivious to. For them, the Alan Greenspans, Janet Yellens, Glenn Stevens and Mario Draghis of the world are still people whose opinions are worth listening to.

My macro view of the world — a coming Greater Depression — is so far out of kilter with mainstream thinking, most people (like the young lady at the cafe) really do not comprehend how an apparently sane person can make this stuff up.

My unorthodox investment strategy (100% cash) is a natural extension of this apocalyptic macro view. This ‘all in’ approach can be labelled ‘conviction investing’.

To date, the whole cash thing has not been a raging financial success. The scoreboard (rather sadly for me) reads shares up and interest rates down. If they blew full time on the investing game today, I’d be well behind.

Fortunately, the game of investing is perpetual. Markets are dynamic. Constantly changing. The markets always give us a chance to right a wrong, or back more losers, or back another winner.

Three decades in the investment game has taught me there are only three certainties in markets — up, down and sideways. The great uncertainties of the three certainties are — which follows which, to what level and for how long.

When the ‘certainty’ you’ve selected on conviction — in my case, a collapsing share market — hasn’t occurred, you can find yourself in a very lonely place. To add insult to injury, another day passes and the share market reaches a new high. Waiting for your ‘certainty’ to have its turn can seem like an eternity. Doubt creeps in… For the record, yes, I question my assumptions often.

The basic assumptions underpinning the ‘end is nigh’ macro view are:

  1. You cannot solve a debt crisis with more debt. The world is US$57 trillion more indebted than it was in 2008. If the world teetered with accumulated debts of US$142 trillion in 2008, how is it going to fare now that it has US$199 trillion (and growing) of debt? This is the biggest debt pile (as a percentage of GDP) the world has ever seen. Every single debt crisis in history has the same unhappy and messy ending. What makes anyone think this one will have some kind of ‘rom com’ happily ever after type ending?

  2. Reversion to the mean. Every single long term US share market valuation metric has the needle pointing to either over-valued or extremely over-valued. Unless we’ve entered a ‘new normal’ in valuation metrics, reversion to the mean is still a valid mathematical assumption.

  3. Baby boomers — the drivers of credit based consumption for the past 30-years — are transitioning en-masse into retirement. A lower return investment environment means the cavalier credit card fueled purchases of yesteryear are being replaced with a more cautious cash based consumer attitude — at least until Generation X comes through in sufficient numbers to pick up the slack.

  4. Central banks openly buying government bonds (to finance government budget deficits) has a look, feel and smell of ‘something is not quite right’ about it. If this is a sound economic principle, why wasn’t it being done before the GFC? In my simple world, this constitutes a case of ‘desperate times calling for even more desperate measures’. Hardly a sound basis for investing in risk assets.

  5. Ultra low and even negative interest rates are a reflection of a very sick economy…one that is on life support courtesy of global QE efforts and history making interest rate settings. The sick (and getting sicker) economy is at odds with a booming share market. If something can’t continue, then it won’t. Either the economy regains health or the share market joins it in the intensive care ward.

  6. China quadrupled its debt from US$7 trillion to US$28 trillion between 2008 and 2014. This explains our GFC savior, the ‘mining boom’. Debt accumulation of this magnitude and pace is impossible to maintain — unless of course it is different this time. Even if China just takes ‘a breather’ and debt levels stagnate for a couple of years, the loss of momentum is enough to bring the perpetual debt machine (global economy) to a halt. On the other hand, what happens if a major Chinese bank declares itself insolvent due to poorly collateralised lending? Watch out below!

These are the threads that make up the doom and gloom tapestry.

There is no certainty any of these possibilities will lead to a cataclysmic unravelling of the global economy and financial markets. The central bankers unorthodox efforts to ‘grow the economy out of its debt funk’ could work. But do you want to bet your hard earned capital on that possibility?

As a conviction investor, you must constantly evaluate your choices. It’s essential to assess the risks of being right versus those of being wrong.

If I’m wrong, 100% of my capital will earn 2% (or less) whereas the share market could deliver an average return of 8% (capital growth and dividend). Outcome: a 6% loss of EARNINGS.

However, if I’m right, 100% of my capital will earn 2% (or less) whereas the US share market is vulnerable to a 60%+ fall in value (and take our market with it). Since 2000, a fall of this magnitude is not without precedent. Outcome: a 60% loss of CAPITAL.

If you’ve been around the investing game for a while, you’ll appreciate that lost earnings as opposed to lost capital are two very different experiences in financial pain. The psychological impact of capital losses is reported to be three times as intense as those associated with a gain.

In my opinion, the risks at present far outweigh the rewards.

Only time will tell whether the courage of my conviction was foolish or not. If it was misplaced courage, then a 6% loss of earnings is a small price to pay for the egg on my face.

If on the other hand courage is rewarded, the loneliness will have been well and truly worth it.

Vern Gowdie,
Editor, Gowdie Family Wealth

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Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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