Q4 2016 Newsletter

Whew… What a year! I’ve been uncertain as to how to begin this communication, which resulted in a somewhat tardy mailing. My apologies.

As a rule, I tend to steer clear of discussing or referencing politics (no explanation needed, I hope). My background in fundamental analysis and company archaeology does not easily accommodate uncertain political scenarios. As a bottoms-up stock picker, I’m not paid to worry about politics but, as a top-down strategist, I’m greatly concerned. Since the global financial crisis, we are in a world in which policy really does matter.

What worries ME most with the upcoming regime change? Protectionism is the one issue about which I am most concerned regarding our portfolios. (Does anyone remember what caused the crash of 1929?) The big question for us is whether Trump’s pro-growth, tax-reform and fiscal stimulus policies will outweigh his protectionist views. I firmly believe that free trade is good for global growth, even though Trump has taken a stand against it. Import curbs could cripple U.S. businesses dependent on global supply chains! Hopefully, Congress will reign in his grandstanding and personal biases.

While Trump’s recommended tax cuts and big infrastructure-stimulus package could stimulate the economy, we should be wary of the long-term impact – an unacceptable level of debt. When interest rates and debt levels increase simultaneously, difficult choices will have to be made (tax increases, Social Security, Medicare cuts, etc.). I’ll go on record and state that high-levels of spending while increasing the debt load is rarely a good idea unless times are dire (such as during WWII). It appears that every Trump scenario comes with two severe edges.

So, where does this leave us? Whatever the details that finally emerge, the message is: Spend, baby, spend. Simply put, my belief is that we currently have a two-year investment window before potential damaging policies come back to haunt us.

If all we have learned from the stunning surprises of 2016 is that the unexpected will happen, we haven’t learned nearly enough (Brexit, oil price slump, Comey, Russia hacking, Trump election…)

Great investors practice trying to disprove their investing assumptions to determine whether they are correct. This past year showed how tightly most of us cling to our preconceived notions, how fiercely we resist evidence that we might be wrong and how adept we are at deluding ourselves into thinking we were right all along. Likewise, instead of opening our minds to the possibility of being wrong, investors (politicians?) often wall themselves off from new information that could threaten their views.

When the U.S. stock market produced its worst start to a year in modern history, losing 10.5% in January and early February, terms like “contagion,” “panic” and “fear and loathing” filled the air. Stocks promptly shot up (Goldberg Capital – +20% since 2/11/16). The common culprits in all this are two quirks of the human mind that psychologists call confirmation bias and hindsight bias. The first drives us to seek and favor evidence that confirms our pre-existing beliefs while ignoring warning signs that we might be wrong. The second compels us, after everyone knows the outcome, to believe we saw it coming all along. If you can’t be honest with yourself about the difference between the truth and what you think ought to be true, you may well be intelligent but not rational. True confessions – I thought, after Trump’s victory, the indexes would trail off 10% vs. the 10+% increase Goldberg Capital realized. Admittedly, I was not in my usual contrarian mode!

To be a good investor, you have to be right often enough. To be a great investor, you have to recognize how often you may be wrong.
With more sophisticated data available, investors can purchase crop yields calculated by satellite images, linguistic analyses of speeches by CEOs, credit-card transactions and more. Among the only active managers with an advantage are quantitative funds that can quickly digest this information. For instance, Renaissance Technologies LLC employs ninety PhDs in computer science, statistics and computational linguistics.

I still believe in making money the old-fashioned way. I regularly speak with company executives, scrutinize balance sheets and search for out-of-favor companies trading at inexpensive levels. I’m confident the fundamental approach will see a revival. So much money has flowed into passive funds that investors now are at risk, partly because popular indexes are buying consumer staples and other shares at all-time highs.
Index-tracking funds don’t care about the quality of a business, its management or valuation. The revival of stock pickers will be the next market phenomenon! Rest assured, GCM will be there for this fundamental philosophical shift.

Here’s to the health and prosperity of our nation in 2017!

– Len