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Compounding Returns Through The Age Of Intervention And Speculation

 “The market has been extraordinary, sometimes it’s quite investment-oriented … and other times it’s almost totally a casino. It’s a gambling parlor.”   Warren Buffett

 “You Pay A Very High Price In The Stock Market For A Cheery Consensus.”   Warren Buffett

“Investing isn’t about beating others at their game. It’s about controlling yourself at your own game.” Benjamin Graham  

Markets today raise all kinds of questions for investors. Government spending and debt are rising unsustainably with no end in sight. “No limit” policy dominates markets as never before and this encourages record speculation. 

Overbought conditions, equity allocations and bullish sentiment have reached rare historic peaks at the end of 2023, even as the probability of recession has never been higher in the last 45 years.

Markets make opinions, but short term and year-to-date returns really only matter for Wall Street bonuses and hedge fund payouts. Yet many investors get consumed by this kind of intense short term focus. Many investors get drawn in to playing the wrong game because they have not developed their own winning long term game. 

What seems to work well in the upside of a massive policy induced bubble, suddenly fails and then equity allocations halve again over the next decade or so, as investors slowly take their losses. Look at what happened the last two times we reached this level of participation in equities. 

You can’t predict what will happen or when, but you can prepare. Put in place a “no matter what” durably successful game plan. Adopt the durable approach of the most successful investors of all time over multiple decades.   

Aside from the importance of avoiding losses, short term returns tell you very little. You need at least 5 years of returns to be able to measure the balance of risk and return, as well as skill and luck. Lose any obsession with short term returns. Get a better context.

For the most successful investors of all time, the objective is always the same. Compound your account over time no matter what.  The game is changing all the time but the principles of compounding are crystal clear, fixed, and easy to measure even in real time. 

If you are not focused on compounding your returns you have no idea what your long term return is likely to be. This is the key difference between “Best Investors”, and everyone else. 

Calendar year forecasts and short term returns won’t tell you much. Focus instead on executing your own winning long term game. Learn how to maximize your long term expected return. It can be done as I show in this insight.


Intervention and speculation turns the market to economic relationships upside down, which turns markets into a casino.

The worse the economic data the greater the need for intervention! However, intervention does not fix the economy, but it can delay a recession. Short term thinking says “problem solved”! However, the economic problem just gets even worse. The recession, when it eventually comes, will be worse than otherwise. Complicated!

Central banks are placing all the focus on the price and not the quantity of money. Ignoring monetary aggregates is very dangerous, and centering decisions only on rates may create a larger problem: a market bubble and a real economy contraction.  

In the short term, all that seems to matter is when the intervention will happen, how big it is, how it feeds into the markets and how long it will last. Tough even for short term traders. What does it mean for the economy? Not much, as we have seen since 2008.

It used to be that bad news was bad news. Recessions just needed to be endured and sober economic behavior would lead over time to strengthening balance sheets and a stronger and more durable recovery. However, political and economic behavior now seems to believe that any sign of a weak market, much less a weak economy, needs immediate intervention. Speculators now expect and reinforce market recoveries.

The Fed’s Empire of Speculation and the Echoes of 1929  describes the process well and is worth reviewing. Investing today requires resolving deeply opposite forces in play at the same time. It is clear from the post 2008 record that current policy is broadly unsustainable. An ever weaker economy has to support an ever greater debt burden. At some point that does not add up.

“Best Investors” can still adapt the playbook to produce the desired outcome.

The results below must be considered an educational example of what can be done not reflecting any specific performance. The purpose is to show what long term assessments investors can align with to start thinking and acting like “Best Investors”, and ensuring that they are compounding their long term return. Let’s assume they reflect a 7 year performance period.  At least 5 years performance period should be used for a proper assessment.

The results show the following:

1. The grid below shows the key framework for expected return. The left vertical axis is return, while the horizontal line reflects risk. Compounding requires high “return for risk”, with constant risk management. The more a portfolio is in the upper left of the grid, low risk and high return, the better the portfolio will compound over time and the more an investor’s capital is secure. The green dot, representing the portfolio, is solidly positive and extremely low risk. This means the basic requirements for compounding  are strongly met.

2. The Benchmarks (squares) reflect a wide array of different assets and strategies and how they performed over the 7 year period. A widely used benchmark is a combination of stocks and bonds. This can be replicated by drawing a line between the Blue (bonds) and Red (stocks) squares. The green dot is around 5% above the stock/bond line. That is significant outperformance of a basic benchmark. Consider that any benchmark outperformance is very rare among professional investors.

3. The only benchmarks above the stock/bond line are gold and the “All weather Belchamber version”. This supports my view that gold should be a central part of any long term allocation because it improves performance.

4. Once an investor sees that risk is low, compounding is solid,  and outperformance is clear, the strength of the investment process becomes clear. If compounding is not developing then something needs to change and an investor has their own objective real time assessment to engage in a much more productive discussion with an asset manager.

5. Over time, this is not at all a low return option. It reflects a broadly low income period, in a record bull market in equities. Also, a period of wildly high volatility. Over time, through a full cycle, I expect a good manager to outperform all benchmarks, with still low risk.

6. This is a different way of thinking and much more clear and stable and  aligns with “Best Investor” Best Practice. Short term returns tell you almost nothing about compounding.

Summary

As 2024 begins, economic weakness provides a fertile background for aggressive policy action. Intervention support seems costless in the current environment. So the recent intervention is likely to continue to be supportive.

That being said the market is extremely overbought, and sentiment and allocations are also extremely high. Furthermore, some negatives will come into play. A recession remains objectively very likely. Supply of government bonds is reaching new records, and the level of policy intervention could eventually be inflationary if it continues at the recent record pace. Intervention most likely will continue over the year, but may have less impact as it is now increasing expected. 

As 2024 begins, economic weakness provides a fertile background for aggressive policy action. Intervention support seems costless in the current environment. So the recent intervention is likely to continue to be supportive.

That being said the market is extremely overbought, and sentiment and allocations are also extremely high. Furthermore, some negatives will come into play. A recession remains objectively very likely. Supply of government bonds is reaching new records, and the level of policy intervention could eventually be inflationary if it continues at the recent record pace. Intervention most likely will continue over the year, but may have less impact as it is now increasing expected. 

The key Questions yet to be resolved are:

1. Does supporting higher stock prices heal the economy despite the dismal growth record of the last 15 years? Likely not, but it does buy a great deal of time, but how much time?

2. Or does endless excessive intervention eventually lead to inflation? This is the key question for 2024 and 2025. This is why bond yields, the dollar and commodities will be key “tells” as to both outcome and timing.Don’t predict. Prepare. Adopt “Best Investor” standards and compound your returns no matter what.


Best Practice is a matter of your Best Interest.


Education and a Commitment to Informed Consent is an Obligation.

Chris Belchamber is an IRMAA Certified Planner

Medicare’s IRMAA impacts every retirement plan. Learning how to mitigate it is available via IRMAA Certified Planners designation.

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