The start of a new year often leads me to reflect on my life and the progress I have made personally and professionally over the previous twelve months. But, with the start of a new decade (yes, I realize there was no Year Zero), I found myself being even more reminiscent than usual as I looked back on the course of my life over the past ten years. At the start of the 2000s, zeros, aughts, or whatever the parlance of future generations will anoint this past decade as, I had not even begun my career with Bell Investment Advisors. In fact, I was working for a small business accountant in San Luis Obispo, California. Ten years certainly passes quickly as that time in my life seems like eons ago.
The recollection of my previous employer immediately made me think of a conversation that my then boss and I had just about ten years ago. We were on our way to a client’s office, and we were listening to business news on the radio as we drove. The report that sparked our conversation was that, for the second year in a row, the Federal government projected a budget surplus in 1999, the first consecutive years of surplus since 1956–1957. The reporter then opined that if these sizable surpluses continued, it was conceivable that the national debt could be retired in our lifetime. Upon hearing that, my boss asked what I thought the financial markets would use as the risk-free asset if there was no longer any debt issued by the U.S. Treasury. I suggested that the debt of government-sponsored enterprises like Fannie Mae and Freddie Mac would fill the void left by Treasuries because they were nearly as safe given that they were implicitly guaranteed by the Federal government.
I think my mind recalled this conversation because it sounds so ridiculous now, and my amygdala knows that I find irony to be quite humorous. But, there is more to take away from this anecdote than just a good laugh; there also exists an important investment lesson here. Ten years ago, it was actually conceivable that the national debt could be paid off during our lifetime, and the possibility that Treasury debt may not be around to serve as the risk-free asset was a legitimate concern. Fast forward ten years later. Now, we are running record budget deficits in the trillions of dollars, and the national debt is rapidly growing with no signs of slowing down. Today, if I used the front page of this newsletter to discuss potential replacements for the risk-free asset once Treasury debt was completely retired, you would justifiably think I was crazy.
That is the problem with predicting the future; it is completely unpredictable. Our view of the future tends to rely on historical data and an extrapolation of present events. Extrapolation proves problematic because things change, sometimes dramatically. As the last decade began, who would have thought amidst a booming economy and burgeoning budget surpluses that the Federal government would be running trillion dollar deficits just ten years later? Who could have predicted that the seemingly safe debt issued by Fannie Mae and Freddie Mac, which was then implicitly guaranteed by the Treasury, would eventually be explicitly guaranteed after the government was forced to rescue both companies from bankruptcy?
Using history as a guide often fails because occasionally the entire paradigm shifts, leaving us with no frame of reference. No historical precedent exists to understand the effects and consequences of a worldwide economic slowdown and the subsequent coordinated efforts among governments to provide massive amounts of financial stimulus. An integrated, global economy is a relatively new phenomenon, and the scale of current fiscal and monetary stimulus packages has never been seen before.
Despite their obvious perils, prognostication and forecasting have unfortunately become the key driver of asset allocation for many investors. Project what the future will look like; determine which asset classes, industries, and countries will benefit; invest accordingly. The problem with this approach to investing is that the future is not knowable, and investing based on what is not knowable is not really investing at all—it is speculation.
Regrettably, this mentality towards investing is encouraged by our industry and the financial media. This time of year business magazines publish their annual “How to Invest in the Coming Year” editions. CNBC fills much of its air time with experts telling you where the market and economy are headed. Even as I was typing this, I received an email invite to my professional society’s Annual Forecast Dinner. As a result of this conditioning, the most frequent question I am asked when it is learned that I invest professionally is, “Where do you think the market/economy is headed?”
To be successful investors and proper stewards of our clients’ assets, we accept that we do not and cannot know what the future holds. Therefore, we have always utilized a completely agnostic strategy based on performance momentum that adapts to changing market and economic conditions. We do not forecast where the market will be at year end nor what the global economy will look like in ten years. Instead, we closely watch the inherent trends in the global financial markets. As trends and conditions change, we change with them without interference or bias from previous forecasts.
Presently, with economic uncertainty and regulatory risk running high, combined with the unknown lasting effects of increasing government intervention and unprecedented amounts of stimulus, we believe that our agnostic, adaptive strategy holds more value now than ever before. If any environment lent itself to successful long-range prognosticating, it is certainly not the present one with the economy and financial markets in uncharted waters in many respects.