The Nut Flush
“The most important thing you must know is the direction from which the wind is blowing… There are clues everywhere; flags, smoke, dust, moving clouds, ripples on the water, other sailboats and blowing debris.”
– Roger MacGregor
I was reading a thoughtful piece by John Hussman, of Hussman Funds, in which he drew an analogy that really hit home with me. He wrote, “Investing is a lot like sailing – you can go anywhere you wish without forecasting the wind. What is essential is to measure the wind properly and often, and align yourself with prevailing conditions.”
Hussman’s point, one I agree with, is that a macro viewpoint (“the big picture”) is essential to getting where you want to go in investing. However, it is a macro viewpoint with a difference. This is not forecasting where the market is going to be at the end of the year, or making predictions about interest rates or oil prices. That sort of prediction is fruitless, as Fleet Street subscribers are already aware, and is not likely to add to your profits. Worse, it may hurt your ability to make money in the market, as these sorts of macro predictions are often wrong.
No, this type of “macro awareness,” or top-down viewpoint, is characterized by analyzing the clues. As MacGregor says, the clues are everywhere. I am not going to make predictions about where the market is headed, but I am going to watch the market climate for clues, looking for dangers that Fleet will steer clear of – and also for opportunities.
There is a difference between recognizing dangers and making a prediction that something bad is going to happen. As Hussman writes, “An open quart of gasoline next to the barbecue is a recognizable danger, but need not resolve into any particular outcome. It’s just the outcome isn’t good on average.”
In a similar way, when I take a bearish view of equities generally, I am not predicting that they will decline. I am noting that given the valuations of today and given what we know about financial history, the returns from stocks in such a climate has not been good.
With this backdrop, we know to be careful and selective in this market, more so than usual. Investing in the 1990s when the markets were strongly rising was much easier. Even your mistakes generally still made money – they just lagged the indexes. Not likely this time, when the overall market is more likely to stagnate or decline.
My investment philosophy is one that stays rooted in present possibilities and probabilities, and it is not dependent on skillful clairvoyance.
I always come back to poker. I love to play poker, and there are great lessons in the game for investors. In fact, many great investors play poker and have made the same connections. Peter Lynch, in an article appearing in Bloomberg several years ago, recommended that all investors take a course on poker to improve their thinking about investing, and specifically about how to think about risks.
In poker, as in investing, you are dealing with uncertainty and with limited information. You don’t know what cards are going to come up next. However, there is a rational way to deal with that problem. You deal with uncertainty by thinking in terms of probability.
In other words, you don’t think about your hand in terms of what could happen in this instance as much as you are thinking about your hand in terms of what would happen if you were in this spot many times, over repeated trials. You are thinking about long-term probabilities.
Sure, there are going to be times when someone pulls an improbable card and beats your hand, but that should not change the way you play the hand next time. You should focus on the long term probabilities. Great poker players think more about the process and experience of playing poker; they are not focused on their short-term results.
In the short term, anything can happen. But over the long term, the better players get the money.
Investing is a lot like poker. Great investors stick to their knitting – they stick to what they know and realize that sometimes it is not going to work out. Even the best investors lose money. Peter Lynch said that all you need for a great track record in investing is to be right six out of 10 times.
What great investors don’t do is change their approach just because it didn’t work in one instance. They realize that in the short term just about anything can happen. They look long term and stick with their proven investing philosophy.
At Fleet, we take the lessons of sailing and poker to heart. We have an approach that has worked for us, one that is built on insights from the world’s greatest investors. It is a comforting thought as we navigate our way through the uncertain waterways of the investment world.
Christopher Mayer is the editor of Capital & Crisis and a commercial lender for Provident Bank in the suburbs of Washington, D.C.