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© 2017 by Coastwise Capital Group, LLC 

On Predicting Macro Economic Events and Their Effects on Stock Prices – The Little Prince

April 26, 2016

In honor of the Queen’s 90th birthday – as well as Prince’s death - this month’s Coastwise Dividend Newsletter is dedicated to royalty.

 

On April 17th, an announcement came out of Doha that no deal was reached on freezing, let alone reducing, oil production. Oil futures quickly plummeted and Asian equity markets dropped precipitously. US stock futures sank and it looked like Monday was going to be an ugly day on Wall Street (especially for oil/oil related stocks). The feeling that Sunday night in New York was akin to the nervousness associated with China’s currency devaluation last summer, which lead to a (temporary) stock market selloff.

 

And then oil rallied. Major oil companies (as represented by the XLE) spiked on Monday and have continued to go up despite most oil analysts predicting on April 18th that oil was headed straight to under $30 a barrel within weeks (it now trades near $45, approximately a 10% gain since the failed Doha talks).

 

If young Crown Prince Mohammed bin Salman himself had whispered in your ear on Sunday that no deal was to be reached and you made ‘logical’ oil related bets accordingly, you would have lost your shirt. In more than 30 years of investing and trading, I have seen countless occasions when either: 1) the macroeconomic news was entirely unexpected (jobs reports, inflation news, Fed decisions, etc.) and/or more importantly, 2) the market’s reaction was counter-intuitive.  There is a reason why Warren Buffett is on record saying he spends less than 5 minutes per year assessing macroeconomic news: it is the earnings of companies over time and how these earnings are valued which, along with the payment of dividends, lead to long-term appreciation. Spending time parsing every last word out of a Fed Chairman’s mouth may make for entertaining financial news, but it will not enhance your bank account in the years ahead. If the mother of all macroeconomic news - S&P’s first time ever downgrading of US Debt from its longstanding AAA rating in August 2011 (with a multi-year bond and stock market rally following) – was not enough to convince you to refocus your attention to corporate fundamentals/earnings (not constantly shifting macroeconomic events) then I am not sure what would.

 

King Dollar

 

The US dollar is the subject of much discussion in investment circles. A common argument is: “The US is totally screwed up, our political system is in shambles, we are becoming a 3rd rate country, the dollar is going down…” This assessment is partially true, but the premise behind it is often misguided. You need to look at the dollar in two ways: 1) as a store of value, and 2) as a currency relative to other currencies. Taking the latter first, many even very smart investors (Buffett included) have been predicting the decline in the value of the dollar relative to other currencies for many years, only to be proven wrong. For example, a few years ago €1 Euro could buy about $1.40 US, while today it can only buy around $1.13. The two currencies almost hit parity not long ago. The point here is that currencies strengthen and weaken relative to each other on an ongoing basis. To the surprise of many, the US dollar has been very strong the last half decade or so despite our exceedingly loose monetary policy. The US may be “screwed up” but many other countries are even more so, hence the relative strength. Trying to predict currency movements, let alone their impact on stock prices (many US based companies with overseas sales do their own currency hedging), is not necessary for the long-term wealth creation that owning a well-diversified basket of stocks can afford.

 

The aforementioned first aspect of the dollar, as a store of value, is crucial when it comes to investing. Often – especially during market sell offs – you will hear the comment that “cash is king.” Certainly in the near term to protect against (unpredictable) short-term stock market movements, or more to the point to have available to take advantage of lower prices when these inevitable declines occur, cash could be considered royalty. But over time cash holdings are nothing but paupers. When people state that the dollar is ‘terrible’, what they really are (or should be) referring to is the fact that held dollars have historically lost around 3% of their value per year due to inflation. For some long term perspective, a dollar held from 1802 to 2012 would have been worth less than 5 cents in real terms. One dollar worth of stocks in 1802 would be worth $704,997 in 2012 in real terms based on historical returns. Just for fun, $1 of gold in 1802 was worth $4.52 in 2012, and $1 in bonds worth $1,778. The power of long-term compounding comes through strongly in those figures.

 

Bringing the time frame to something more meaningful, a dollar held by a 50 year into retirement would be worth less than $0.50 by the time he/she had to start taking RMDs from an IRA. So if inflation is such a killer when it comes to the value of cash in our accounts then what are we to do? The answer is: hold a well-diversified basket of stocks, preferably a core holding of dividend paying stocks which are an excellent way to grow your money beyond that of inflation over time. “But aren’t stocks so volatile?” you ask. “Just look at the start of 2016....” Yes, in the near term, stocks can move up and down rapidly, but when you take a step back and see the forest rather than the trees – or more specifically assess volatility across your actual holding period which is years, not months or days - then the picture changes dramatically. Using Q1 2016 as an example, one could state it was extremely volatile. Many US stock indices entered bear market territory in February and several records for ‘worst start to a year’ were broken. If instead you looked at your January 1st statement and then your March 31st account balance (a whole 3 months!), you would have rightly concluded it was a tame first 90 days of the year, the market ending Q1 essentially where it started.

 

Bottom line, you should set your expectations such that periodic stock declines are not something you fear in your long-term journey of wealth creation. Interestingly, despite all the concrete empirical historical data showing how quickly stocks can recover from declines (the mid-February to the end of March 2016 period being just another in a long list of examples) our phones invariably ring far more when stocks are down then when they are up. While I have received countless calls over the years from investors expressing how much they are in fear (actual word used) over how their portfolio with a 15–25 year time horizon is doing today (during a market decline), I can’t remember the last time I received a call after a big rally with someone expressing fear over their stocks being overvalued.

 

All this brings me to someone who many in the investment world consider royalty, Warren Buffett. He states that the most important traits to being a great investor have nothing to do with your IQ nor mathematical skills. What makes an investor successful is emotional stability and patience. Someone with those characteristics would view what occurred in Q1 of 2016 as a non-event at worst, or at best an opportunity to invest more money at lower prices (many high quality blue chip stocks rallied 30% + off their February lows, e.g. big Buffett holding IBM increased from $116 to over $150 in under 30 trading days). Those lacking emotional stability and patience must arm themselves with means to keep themselves from self-financial harm. This is one of the greatest values a rational, long-term acting professional money manager can bring… to keep an investor from making short-term emotions based decisions that could harm his long term financial health.

 

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