What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital.
Defensively Optimistic
We are at a point in the bull market cycle where macro fears are at a level that has not been experienced since the entirety of the developed world thought that the global economy was headed towards a Fred Flintstone period of stone wheels and wooly mammoth vacuum cleaners. Fortunately, we managed to avoid such a dreadful fate, returning to prosperity post-2009 much more persistently than most would have expected.
The persistence of this new cycle of prosperity has managed to catch the stewards of capital across our global economy somewhat flatfooted. As a result, we are now witnessing a reallocation of capital away from asset classes such as commodities and emerging markets. The instability created from this reallocation of assets is effecting emerging market economies, such as China and Brazil, with the vibrations from those shocks creating the illusion of instability in the U.S. economy.
While we are certainly experiencing a contraction in revenue/earnings growth, Wall Street analysts have a tendency to overreact on the downside. That overreaction sets the markets up for generally positive surprises from companies that are less weighted towards global industrial exposure. Those surprises to the upside should come from financials and technology, which I expect to lead the markets out of this correction beginning in October.
It is important to remain defensively optimistic in the face of such unjustified pessimism during what has been one of the strongest secular bull markets on record. Defensively optimistic means that there is a controlled tendency towards long positions, as opposed to a leveraged, let it ride mentality that leads so many investors astray. Skilled stock picking alongside generally rudimentary risk control practices goes a long ways towards stabilizing a portfolio within such an environment.
The tendency towards excessive hedges and an overabundance of cash in a portfolio at this juncture of the bull market is a conventional stance that will invariably lead to conventional results. Those who participate in this type of fear based investing that is curve fitted around seemingly relevant fundamental data points will very simply be left in a cloud of dust, as they have been during the entirety of this bull market. Being defensively optimistic as opposed to chronically defensive continues to separate the outperforming portfolios from the rest of the bunch.
A Game Of Risk Obfuscation
For all the resources and time spent on obtaining the pedigree necessary to thrive on Wall Street, the true professional after years of perfecting their craft does not become a master of interpreting company fundamentals, reforming an inept management team or timing the market perfectly. Rather, the true professional on Wall Street becomes a master of obfuscating risk.
This matter of risk obfuscation bears its fair share of responsibility for a great many of the ills suffered by investors who think they are buying one thing when they are being sold something else entirely.
Different institutions have different ways of obfuscating risk. In the 90s, there were the Janus Mutual Fund commercials that were essentially bragfests for how Janus fund managers show up at the slaughterhouse of a meat processing plant and weigh each side of beef in ratio to the weight of excrement being delivered by the cows to insure that earnings are calculated to the exact precise degree so they could absolutely nail an investment in meat processors every single time.
The message was that Janus was so involved with management that risk was nearly nullified through what amounted to being an insider at the company. The funds promptly lost more than 50% of their value following the internet bubble bursting in 2000.
Of course, the most infamous case of obfuscating risk came with Long-Term Capital Management. A group of Nobel Laureates so dignified in their pursuit of extraordinary capital gains that the markets would be at their beck and call. They had developed a system of extracting gains from the markets that was both dynamic and full proof, trading in nearly every market around the globe.
The message here was that this group of investors was so smart that losses of any substance would simply be avoided due to sheer brilliance. In 1998 Long-Term Capital Management required a bailout from the Federal Reserve due to the extent of their losses, which briefly jeopardized the entire financial system.
These previous examples are extraordinary cases of obfuscating risk by large financial institutions. The majority of Wall Street obfuscates risk by simply attempting to fly under the radar. They do so through closet indexing and copycat trading. The hope here is that they can just keep up with their benchmark on the upside and when the downside hits, they simply revert to a peer to peer comparison in an effort to convince investors that the risk is systemic in nature, with a reversion to the mean being imminent.
The driving force of the great investors of our time has been to pursue a passion for investing in the best situations possible. They did so through a nearly maniacal obsession with mining the markets, analyzing situations and developing strategies that afforded them the skill and confidence necessary to make a tangible difference in the wealth of their clients.
When billionaire David Geffen exited Eddie Lampert's ESL Investments in 2007 he stated that he had made more money with Eddie Lampert since initiating his investment in 1992 than he had “from all the businesses I've created and sold.”
There is no need to obfuscate risk when you are a competent investor. Your risk is in your analysis. Your system of investing can be explained in a few sentences. Your system of controlling risk is the recognition that mistakes in analysis occur and taking steps to correct those mistakes quickly.
This is the old Wall Street method of investing. It has become a lost art that has been replaced by an attention to every single detail while ignoring the few relevant facts that make an investment attractive.
The competent investor should be able to articulate his methodology on the back of a napkin. Anything beyond that moves into the realm of risk obfuscation, which should create an intense curiosity as to what it is exactly that investor is attempting to cloud.
Regards,
Ali Meshkati
