Last week, Laura Carley and I attended the 69th CFA Institute Annual Conference in Montreal. Over 2,000 Chartered Financial Analysts gathered from 70 different countries. It was like a big global nerd convention. It turns out that nerds from other countries are a lot like nerds from the USA.
There are always a few good nuggets that can be taken away from this conference each year. Here are a few of them from last week’s:
1. The Chinese economy is going to continue to slow down. Big time. A country that grew annually at 10% for many, many years has hit the inevitable wall (pun intended). Currently with a growth rate of roughly 6%, we are looking for China’s growth to shrink to 3% or less. Almost immediately.
The reality is that the majority of China’s previous “growth” hasn’t come from consumption (like the purchase of an automobile or an iPhone). It has been from investment or government outlays (like the construction of a stadium or an office building). A nation’s Gross Domestic Product (GDP) is the sum of all economic activity (consumption, government outlays, investments and net exports).
The slow, gradual economic time bomb that has become China’s problem is that too much of China’s “growth” for the past twenty years has come from investment and government outlays and not enough from consumption.
For example, when a country builds an interstate highway, that highway is considered an “investment.” Since we need highways, it makes sense to build them. Once you have all the highways you need, it might even make sense to go back and expand some of the busy four-lane highways to eight-lane highways, maybe even 12-lanes like in Los Angeles (and traffic is STILL bumper to bumper).
At some point, the marginal value of adding additional lanes becomes zero. In the U.S., we quit adding lanes at that point. China, on the other hand, has elected to continue building a lot of things that are not necessary. In fact, entire cities have been built that are virtually uninhabited. Building unnecessary roads and office buildings is highly unproductive and has made China’s GDP look greater than it really is.
And China’s demand for raw materials to build these structures has been a boon to countries that produce and export those raw materials (like iron ore, copper, oil, etc).
Once a country has built most of what it needs to function as a country, then consumption should become the main driver of economic growth. Consumption is close to 60% of GDP in the U.S., but it has been about 35% of China’s GDP.
Therefore, until consumption increases significantly in China, the fall-off in investment and government outlays will bring China’s growth rate down dramatically and immediately.
The takeaway from this is that global economic growth, which has already slowed, cannot rely on the second largest economy in the world to kick-start it. Look for continued slow global growth and commodity prices to remain low due to weak demand.
2. The price of oil is not going back to $100/barrel. Barring a major destabilizing event in the Middle East, oil is likely to stay closer to its price today. The long range average price of oil is closer to $45 than $100. $100 per barrel oil was an aberration, not the norm.
Alternative sources of energy, cheaper sources of fossil fuels (fracking) and the global economic slow-down are things which will prevent the price of oil from rising back to $100.
3. Contrarian investing is still the best way to invest. Investing where others are NOT investing is one of the best long-term strategies around.
If you have been a client of BCWM for more than six years, you may recall that in 2010 we invested significantly in municipal bonds from cities and school districts in California… at precisely the time when the “demise of anything California” was a popular theme. We didn’t just invest in municipal bonds. We invested in zero-coupon municipal bonds, the most aggressive type of bonds you can purchase.
Many clients questioned this strategy, a few thought we were crazy and one client actually transferred their account to another advisor.
We were reminded that being a contrarian investor can be painful temporarily. You can look foolish for a long time before you start to look like you know what you are doing. This was true in 2010. As we started buying California municipal bonds, they continued to decline in value for almost a year before the rest of the investment world began to realize what we had already realized… that California school districts were not going to go bankrupt and that a bond priced to yield 7.5% tax-free was a pretty good deal. They finally hit bottom and rallied furiously for the next three years, providing clients with healthy returns. NOT ONE California municipal bond that we purchased had financial problems.
More pain came last year as we began to move investment funds into emerging markets, which had been horrible for seven years. It was difficult to be more contrarian than that. And, of course, they continued to decline after our initial investment. However, since December 30th, our investments in Brazil, Chile, India, Russia and South Africa are making us look a little less foolish with double digit returns in just the first four months of 2016.
Anyone who is managing other people’s money will experience the following if he/she is a contrarian investor:
- You will be guilty until proven innocent
- That was certainly the case in almost every client meeting after we bought California municipal bonds. “You put our money in WHAT? You’ve got to be kidding!”
- NO good deed goes unpunished
- Clients may fire you – that happened
- Looking foolish vs. being foolish – being contrarian is harder because it is difficult to “pick the bottom”
- You can look foolish for a long time before you begin to look smart
- Patience is in short supply, pandering is in high demand
- It’s difficult to convince someone that you are right when all the current evidence points to you being wrong
4. The average investor is an emotional idiot (I paraphrase). Because of our emotions, we tend to make investment decisions that are not good for us. We have to be careful to avoid behavioral pitfalls like:
- Representativeness – using a small sample as representative of a larger sample. When we don’t have an opinion, we form one too quickly based on too little data
- Conservativism – where people under weigh sample information. Once we HAVE an opinion, we are slow to update our opinion based on new data
- Overconfidence – just like we think we are better automobile drivers than other people, we can also make the mistake of thinking we are better at trading stocks. (At BCWM, we know that humility is a valuable trait in portfolio management)
We learned long ago that to be successful in our line of work, we have to be able to walk in the door every day and be able to say, “Yesterday, we were wrong.” This allows us to admit mistakes and quickly fix them before they become larger mistakes.
We’re already looking forward to the 2017 70th CFA Institute Annual Conference scheduled to be held in Philadelphia, followed by Hong Kong in 2018. More nuggets then…
Later this month, Cory Bloodgood and I are spending a few days in Dallas at the Strategic Investment Conference. This conference has an impressive lineup of speakers and always provides great investment insights.
April was a rather quiet month with the S&P 500 barely increasing at all. Foreign stocks rallied well, up 2.3%, but they are still down over 13% since last April.
Bonds have had a good 2016 so far with High Yield bonds bouncing nicely after getting crushed the last four months of 2015.
At Boyer & Corporon Wealth Management, we continue to feel that 2016 will be a challenging year for investment returns. Although we feel interest rates will remain low, the threat of rate hikes by the Fed should cast a dark cloud over the equity and fixed income markets.
This information is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.