GW & Wade Principal Offers Perspective on the Markets and Investing
Using Daniel Kahneman's Thinking Fast & Slow as a point of departure, GW & Wade Principal and Investment Committee Chair, Joe Rigali, recently spoke with clients and friends of the firm about the markets and human behavior.
"Kahneman's premise is that we are subject to 'fast thinking,' or unconscious, intuitive decisions, based on context and experience. Slow thinking is more deliberative, critical, and conscious." The problem with fast thinking is that it is easily influenced by immediate stimuli, and the repetition of an idea. This can create a false familiarity, where familiar things eventually begin to feel like true things.
For example, in the current economic environment, we are bombarded with negative global economic news and sense of impending disaster, most recently with the word "euro" attached to it. When Rigali recently Googled "euro zone crisis" he got 229 million hits. So is there going to be a euro zone crisis? Perhaps.
While there may be further ramifications from events in the Euro-zone, constant information flows like this can cause investors to develop a strong aversion toward risk. An advisor's job is to bring "slow" thinking to this environment, and to see if the data tells another story; to examine the data and develop long term plans for each unique situation.
So Where Does Our "Slow" Thinking Lead Us Now?
GW & Wade's investment approach starts with a look at the 3 major asset classes - cash, bonds & equities - and recommends appropriate weightings within each class to try to achieve the best risk-adjusted returns for each client.
Cash: Money Markets, CDs, bank deposits, and treasury bills have actually yielded negative real returns over the past six years. The Federal Reserve has kept rates low to encourage borrowing, ease debt burdens, and encourage investors into riskier asset classes. Still, cash has a purpose in a portfolio: to meet short-term liabilities two to four years out, to cushion living expenses, and to avoid principal fluctuations.
Bonds: Bonds were once seen as facilitating return without risk. Lately, they have provided "return-less risk," with effective rates of return of zero or less, after taxes and inflation. So why hold fixed income investments at all? First, if there is another economic crisis, bonds, and especially US Treasury bonds, will likely provide positive returns.
And in a slow growth environment, income from other bond classes can be adequate. For example, global & corporate bonds currently offer interesting net yields when compared to treasuries.
Equities: Historically, the 15 year average price earnings ratio of the S&P 500 has been 16.9% (JP Morgan study). It currently rests well-below that average, at 11.5%. An under-valued market is one historic indicator that there may be potential value in the market. And Burton Makiel, a well-respected, "old sage" of the market and efficient investing, recently said earnings normally return to long-term growth of 4% to 5%, plus a 2.5% dividend yield (Wall St. Journal, Jan 5, 2012). So why not go "all-in" with equities? There are several reasons:
1. An investor is ill-advised to make big bets
2. We expect volatility will continue to be high
3. We work hard to match client's portfolio to their risk tolerance
Conclusions
Forecasting is a fool's game. But we can learn from history, and the perspective which "slow thinking" provides. Events like the market crash of October 1987, or the burst of the tech-bubble in 2001--events which at the time seemed calamitous--now appear as mere blips on charts which display long-term returns. We do not understate the influence of risk in the political and international arenas. But we have learned this: over time, and especially over rolling, ten-year periods since the mid 1950s, an appropriate allocation to a variety of stocks, along with an overall, well-balanced allocation in other asset classes, have reduced the risk and volatility in our clients' portfolios, while creating returns which have helped them meet their objectives, for themselves and for their loved ones. |
