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The Most Important Thing by Howard Marks
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Transcript
Welcome to the 11th episode of the AMM Dividend Growth Podcast. I’m your host Glenn Busch and I’m the lead portfolio manager for the AMM Dividend Growth Strategy at American Money Management.
Before we start the episode I want to say thank you to the Frugal Billionaire for leaving the rating and review. I greatly appreciate it and I hear you about uploading more episodes. I’m always looking for ways to add more content and to produce a more consistent podcast. My goal with this podcast is to really dive into our portfolio. What we’re investing in and why and how we’re managing a concentrated portfolio. I don’t want this podcast to be just a stock idea podcast so this narrows down my content options. Just so you know we do have some shows in the pipeline. We just sent out the next dividend letter and I’ll convert that to a podcast episode shortly. I’m working on another dividend stock to avoid episode. And I’m doing this episode which is based our quarterly letter that we sent to all clients of AMM.
While it’s not specifically about our dividend growth strategy it gets into our 5 core principles, our investment philosophy, and how we manage portfolios in an uncertain future, which applies directly to how we manage our dividend growth strategy
So let’s do the disclaimer and get into the episode.
[disclaimer]
A few years ago, myself and Michael Moore, our Chief Investment officer not the film maker, attended the annual forecast dinner for the San Diego chapter of the CFA society. Which I think is in late December maybe early January.
Anyways, at this dinner all of us professional money men and women submit their stock market return predictions for the coming year. It’s been a few years since I went to one of these dinners but I believe the person who gets it right wins something.
I went for something really bold because if I won then people might remember me. No one is going to remember the person who guessed 7% and got it right.
The keynote speaker, and the reason we went, was Howard Marks. He looks over the card with the average predicted returns versus the actual returns. Obviously there is no correlation between the predictions and what the actual returns are but Howard notices something else.
The predictions did fit very closely with the prior year’s returns.
All of us professionals were really good at predicting the past.
What Howard pointed out was the recency bias. Which is how it’s really easy for us to remember something that just happened than something much further in the past.
The recency bias pops up a lot when we’re faced with an uncertain future and have to act like what we do with investing. But investing into that uncertainty is really uncomfortable. So we make predictions to help us. These predictions are heavily influenced by recent events.
I don’t know if this table originated with Whitney Tilson and his Empire Financial Research but we got it off his daily email. The table is the top ten companies by market value at the end of the last 5 decades plus the top investment theme of that decade. I’ll put a link to our full letter in the description so you can see the table.
In 1979 it was IBM, AT&T, Exxon, Standard Oil, Schlumberger, Shell Oil, Mobil, Eastman Kodak, Atlantic Richfield, and GE. The theme was energy.
in 1989 it was NTT, Bank of Tokyo, Industrial Bank of Japan, Sumitomo Mitsui, Toyota, Fuji Bank, Dai-ichi Kangyo Bank, IBM, UFJ Bank, and Exxon again. Obviously the theme was Japan.
At the end of 1999, it was Microsoft, GE, NTT Docomo, Cisco, Walmart, Intel, NTT, Exxon, Lucent, and Deutsche Telecom. This was the tech and telecom bubble era.
In 2009 it was Exon, Petro China, Apple, BHP Billiton, Microsoft, ICBC, Petrobras, China Construction Bank, Royal Dutch Shell, Nestle. This was the decade of China’s growth and the commodity boom associated with it.
Today at the end of the 2010s we have Microsoft, Apple, Amazon, Alphabet, Facebook, Alibaba, Tencent, JP Morgan, Johnson & Johnson, and Visa. The theme is tech again but more specifically the internet and the rise of the mobile platform.
Except for Exxon Mobil and Microsoft, most companies on this list do not repeat as a top ten company in future decades.
What are the odds that the most valuable companies list will be the same 10 years from now? Or that the major investment theme of the 2010s will be the same in the 2020s?
Because the 2010s just ended and the top ten companies feel unstoppable, especially all the tech companies, we’ll most likely overweight their odds of repeating.
The other major investment theme of the 2010s is what we call the state of perpetual panic.
With the market at new all-time highs, viral tik tok videos of kids making money day trading, people hacking the Robinhood app for infinite leverage, the Reddit forum Wall Street Bets, it might be hard to remember all the panic inducing headlines of the past 10 years.
Lucky for us Ed Yardeni counted them all up and they got 65 market panics over the last 10 years. I’ll put a link in the description.
Yardeni defines a panic as a relatively short-lived market sell-off in the S&P 500 of 5 to 20 percent.
Some of our favorites were the Greek Debt Crisis, Brexit, fears of the Fed tapering, the flash crash.
The state of perpetual panic is another effect of the recency. Everyone can immediately remember the Great Financial Crisis. With every fear inducing headline the feeling was this is it. This is the start of the next big bear market. Just because we recently went through it.
But amidst all this panic the S&p 500 had one of its best decades in history. It annualized 13% in the 2010s.
The consistent fear and panic meant investors were not complacent and that the market was pricing in the known risks.
This is a good thing. It is only bad if it drives investors out of the market completely or worse, it has them getting out of the market on bad news and back in when everything has calmed down and prices are higher.
Yes, at some point a panic will lead to a bear market. But trying to predict when or how this will happen is a fool’s errand. Maybe the Corona Virus will finally cause it but we don’t know. We do know that trying to predict when this will happen and investing based on the position has been hazardous to long-term returns. And this is not just for the 2010s.
Instead of trying to outsmart the market or make uncertain predictions about the next 5-10 years, we focus on understanding today and invest according to out 5 core principles.
One. Asset allocation is the most important decision. This is less applicable to our dividend growth strategy since its 100% stocks but in general determining how much to invest in stocks, bonds, real estate, and other assets is the primary factor in your long-term returns and the level of fluctuation in your portfolio.
Two. Volatility is not risk. The real risk is the permanent impairment of your capital. Volatility to us is only risky if it spooks investors and causes them to abandon a well thought out investment policy and sell a fundamentally sound position at a loss.
Three. The price you pay determines your return. Pay too high a price for any asset and you will earn subpar returns. Paying a low price, all else being equal, should lead to attractive returns. After a 10 year bull market, this is getting harder but we remained focused on managing risk by investing at prices that make economic sense.
Four. Time is your ally but returns are not linear. Investment success comes from time in the market not timing the market. We accept the fact that market returns are choppy. But in return for taing on this short-term risk and remaining patient, we seek to benefit from long-term compounding returns.
Five. No one can predict the future: The stock market, bond market, and every other capital market are complex systems. There are way too many variables, participants, and feedback loops to accurately predict the future. You can make probabilistic estimates but that is it. The likelihood that you’ll make an error in your prediction by not incorporating all these variables and factors are extremely high. The other thing is maybe your prediction ultimately comes true. But how long did it take and at what cost.
Making the big bold prediction is probably the most common way to make a name for yourself in this industry. We’re more a put up or shut up type of firm. We follow our rules and our core principles because people have entrusted their hard earn money with us and we want to do the best job we can for them in the most prudent way possible over a long time frame.
Thank you for listening and I hope you enjoyed this episode. If you did please leave a rating and review on your favorite podcast player to help others find us. If you want to learn more about American Money Management and our dividend growth strategy visit us at www.amminvest.com. That’s alpha mike mike i n v e s t dot com or you can give me a call at 858-755-0909.
Until next time.
