I seldom encounter a market that I don’t have a decision tree. This market might be one that I have no idea how it will go.
It looks like none of the country’s leaders want to back down and if this remains, the production cost will be so much more expensive, that it will bring either inflation, falling margins, resulting in overall lower earnings per share.
That means companies should be value more cheaply. The market will go to shit by then. Why kill a perfectly fine market?
The moment the bullet missed him and gave him a lease of life, this sort of gave him an epiphany they are saving him to save America. Whatever reservations Donald Trump had in his first term might have disappeared. Many don’t have a clear playbook except that we might be in a different “more volatile” regime than previously thought of. You might also say we are in a more closed-off, de-globalized world.
If so, I think as Singaporeans, we might need to worry about our role in this global landscape more than the financial markets, since most people are still accumulating.
In any case, things do not become clear cut overnight. There might be countries or regions that would try to find their way round this.
Some investors would wonder: What is the playbook in a de-globalized world?
We won’t know if that will really happen, to what degree and how fast that will be. It is challenging to define the playbook if things are so uncertain.
In my old role as a retail portfolio manager, I would have wait until the coast is clearer, when I can maybe see clearer the revenue and earnings profile to make the big moves. Then I will think though how these prospective companies will fare, if they would be greatly impacted positively or negatively by these risks.
In this current role, that might be less useful if I run a Strategic Systematic Portfolio (which is what Daedalus Income portfolio is).
If we look at a system, the question is whether Daedalus has features to navigate the potential future scenarios that can occur. And it is whether the portfolio can tackle a more uncertain and volatile investing regime. Perhaps you can call it a secular chop or secular bear.
Investors currently are very used to V-shape recovery and the market going higher. Well if you are a REIT investor, Hong Kong, Asia Ex-Japan, US Small Cap investor, you may have just endure 7 years of chop. So V-shape recovery might only ring through if you have a high US equity concentration.
We might be entering an environment that the US large cap will chop. I say potentially but not always.
What does chop look like? I can bring up the examples of those few regions but… here is the US large cap in the period of 1968 to 1980:
Instead of wondering about what is the play book what to invest in… perhaps we should admit that many regions will go through a period of chop like the few said markets. I think many of us refuse to accept that, and focus on the strategy to invest in areas that won’t chop before hand.
If those folks know that REITs is going to chop before hand, then do you think that they would have invested in the first place?
The key attribute about the condition is the challenge of seeing things clearly beforehand in order to make tactical shifts in our portfolio.
So back to the chart above, this is a period where US (or the world) went off the gold standard. There is also oil shock, during a period where the economy is much, much more dependent on oil.
And so for about 10 years, the US large cap chopped. Note that this is a nominal total returns (including dividends) growth of $1 chart. If we factor in inflation, it will be tougher.
Your heads will burst if we factor in inflation-adjusted returns and try to tackle the problem.
What you will notice is within that 10 years, there are like 3 major drawdowns and subsequent recovery.
If we measure the returns for the 12 years, $1 became $2.38 which is not bad, but I doubt many of us can live through that chop.
Some people would say cash is trash, bond is trash during that period. Well yes.. that may be true, but here is the performance of a US 5-year Treasury over the same time period…. I am not sure I would complain if I kind of reach the same place but with far less volatility.
Those periods where I mark with gaps would be people evaluating about why the fxxk do I invest in equities when even this Treasury give me returns? The last gap would be the place where equity investors throw in their towel and gave up.
Which is what I think many did.
Think of how many people gave up on Hong Kong stocks, Asia Ex Japan, REITs, China, US small caps (and mid cap stocks) for the matter currently.
Let me overlay that two index with some Dimensional indexes I gathered:
The US Small Cap and UK Small Cap index gives us the glimpse of the performance of the smaller cap stocks during that period. US Large Cap Value is a strategy of systematically tilting towards cheaper companies. US small cap value combines the small and value.
Why did UK small cap did so well?
I have no idea man. I wonder if the US investor then would know UK small caps can do so well. Instead of $1 mil become $2.3 mil, it becomes $9 mil if they invested in it. The US Small Cap Value doubled the US large cap and the value did 50% better.
There is a few things to unpack here.
I am sure that the environment is very charged whether domestically, geopolitically and risky. I am sure the environment is uncertain. I am sure there are distinct assets classes that performed well.
But often, we either make a read and guess that something will turn out well (read gold) and massively overweight our portfolio in it. But if this comes to a pass, and the last 15 years continues, then you would have missed out.
Being diversified across not just a region, sectors but also sources of alternative premiums such as profitability, value and momentum, may allow you to have a portfolio that is more livable. You could imagine what happens if you realize that your portfolio has not missed out on a potential secular trend shift (like those who think Germany has turned)
Concentrating in a region, in the largest market cap-weighted has its advantage if it works out, continues to work out, but in a world where things are less certain, are you willing to bank on that to continue?
It is up to you.
You can still remain very invested in a region, and the long history of US market returns show that we have regime changes, pivotal events happening and the market survived.
My bet is that living through challenging periods behaviorally is another matter altogether.
Lastly, there is return at the end potentially because of uncertainty but we got to first admit that uncertainty is damn challenging to endure. While I can show some greater returns, I removed a few of the indexes to show you the performance of the good performers.
Notice that for like 7 years, some of them perform the same or did even worse. And then they broke out.
Returns come when you least expected but so does the falls (as you guys might understand it better as of the time of writing). I truly believe the returns are earn by those who can endure the uncertainty and the pain, if they have a long term buy and hold strategy.
If not, they got to find other strategies that they don’t have to endure so much uncertainty.
In a way, these features were built into Daedalus:
- Being more globally diversified.
- Not concentrated in certain sectors.
- Have some fixed income to reduce the volatility.
- Expose to different risk premia (value, small, momentum, profitabilty)
- Being expose to uncertainty
- A spending strategy that appropriately sized the initial annual income based on the portfolio allocation, and capital size.
In order to navigate a world where the regime is clearer and also less uncertain, we got to accept we cannot be 100% right, and build a portfolio that has a best chance to survive and do decently. If we are clear about the playbook, you can choose to be concentrated, and I hope you are right.
I probably think that is a harder camp to play in.
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Kyith is the Owner and Sole Writer behind Investment Moats. Readers tune in to Investment Moats to learn and build stronger, firmer wealth foundations, how to have a Passive investment strategy, know more about investing in REITs and the nuts and bolts of Active Investing.
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Kyith worked as an IT operations engineer from 2004 to 2019. Currently, he works as a Senior Solutions Specialist in Insurance Start-up Havend. All opinions on Investment Moats are his own and does not represent the views of Providend.
You can view Kyith’s current portfolio here, which uses his Free Google Stock Portfolio Tracker.
His investment broker of choice is Interactive Brokers, which allows him to invest in securities from different exchanges all over the world, at very low commission rates, without custodian fees, near spot currency rates.
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