Sunday, December 31, 2017

2017 Year-End Client Letter, Part 6: Conclusion

Link to Part 4
Link to Part 5

At last, it's time to close our year-end message for 2017: 

Herein we've presented what we believe to be the characteristics of good portfolio managers. We've expressed the sense of security we gain in the understanding that while not all good investments make money, if we strive to make only good investments the odds are strongly in our clients' favor over the long-term. We highlighted the whys and wherefores of the sectors we presently like and those we don't. We shared our views on the importance of maintaining a global investment mindset. We expounded on why we think that (despite valuation) many currency traders once again may be on the wrong side of the dollar going into 2018 -- and how it's perfectly okay for our portfolios if they're right this time. And we discussed the not-so-safe nature of today's bond market as well as our presently not so bullish view of precious metals.

All of that time, effort, analysis and presentation aside, the true beauty of markets lies in their perpetual, and unpredictable, motion. We accept (embrace even) the fact that, while our present positioning is the product of intense technical and fundamental analysis, things will absolutely change over time; some things more rapidly than we may have previously anticipated. And as things change so must our perspectives, and so must our allocations.

Bottom line: At PWA our egos are not invested in our positions; we are indeed forever striving to prove ourselves wrong. It's not in the least bit important to us that the market continues its bullish march into 2018, as our analysis presently suggests it may (with, by the way, substantially more volatility than we experienced in 2017 [it'll be uncomfortable, but healthy!]). What's important to us is that we see things as they are, not as how we, or others, might like them to be. 

So, as for our conclusion (pardon the repetition): The macro fundamental setup along with the longer-term technical trends exposed within the charts suggest that probabilities support further equity market gains during the course of 2018. Although we cannot emphasize enough the huge unlikelihood that they'll occur amid the historic dearth of volatility we experienced in 2017. And, most important, we're more than willing to change our views on market probabilities, when (not if) conditions call for it. 

In closing:

We think it fitting to close our year-end letter with the ultimate timeless market message: We'll expose, at the core, what truly dictates the pricing of goods, of services and of shares of stocks throughout the global marketplace: 

Economists tell us that the dynamics of supply and demand dictate the pricing of market-based goods and services -- and market technicians tell us that's also what determines the price of a share of stock. Of course that makes perfect sense, and it's critical to the human mind -- that is, the human mind thinks that it's critical to the human mind -- to make perfect sense of things. In terms of stocks, we show it on the charts all the time.

For example, take a look at our daily chart of the S&P 500 Index for 2017:   click to enlarge...


Following the price from left to right, those horizontal lines depict the price where some would say sellers (supply) and buyers (demand) found equilibrium. However, as you can see, it was always short-lived. Where supply exceeded demand -- areas where the price stalled, then backed off (resistance) -- we colored our lines red. We created a green line when demand ultimately exceeded supply (when the buyers overwhelmed the sellers) and, thus, the price broke above the previously stalled area (previous resistance). 

Note how the green lines rest right atop the red: That would be where regret-ridden sellers -- who abandoned their shares at the price where they previously had their way with the buyers -- became buyers themselves as they fulfilled their vows to get back into stocks if they ever got back to where they previously sold. In essence, what was once resistance (where sellers overwhelmed buyers) thus became support (where buyers overwhelmed sellers) -- which is actually when we create a green line.
 
That's very cool, isn't it? I mean, if you can get your head around the charts, if you can see previous areas of equilibrium, you can make huge money trading against those areas! Right?

Well, let's throw up another S&P 500 chart.

Here's March of 2003 to March 2009:  click to enlarge...


Following left to right, playing support and resistance areas might have been nicely profitable for the self-proclaimed savvy trader; that is until the real estate bubble burst! My how previous support (briefly equilibrium) proved utterly nonexistent -- how sellers overwhelmed buyers -- when fear gripped the human psyche.

Review Part 2 for an explanation of how we come to terms with the risk illustrated in the chart immediately above.

Now, despite what the last chart above depicts, despite history, despite, frankly, what our eyes and our experiences tell us, far too many economists and, alas, market analysts would have us believe that the laws of the physical sciences can be applied to economics and to markets (areas that clearly fall within the realm of the infinitely less quantifiable social sciences). That the laws of economics and markets 
summarize and explain a large collection of facts determined by experiment, and are tested based on their ability to predict the results of future experiments. They are developed either from facts or through mathematics, and are strongly supported by empirical evidence. It is generally understood that they reflect causal relationships fundamental to reality, and are discovered rather than invented.;
that we can observe supply/demand curves, determine equilibrium and thus act accordingly. That, in stock market terms, we can chart (as we have above) supply and demand, or, better yet perhaps, we can apply a valuation model to a stock, or a currency, etc., and come up with an investible thesis that is sure to make us wealthy. 

Well, as all investors, amateurs and pros alikehave or will come to realize, it's just not that simple. Nevertheless, the market gurus persist: They explain how the supply/demand conditions of silver for example demand a $30/ounce price, while it continues to change hands in the teens. They dazzle us with discounted cash flow analyses (yes, we do it too) of, say, Apple, and place its true value at $200+/share (for years now), while buyers and sellers are presently content with $170ish. 

While it is not our intent to entirely denounce or debunk the value of conventional economic/financial market thought, we just find that a strict adherence to what we view as its conjectures can be most dangerous when it comes to investing one's money. We think it's safer, healthier, and ultimately more profitable to couch market pricing as the sum result of the decisions made by the 7 billion human beings who inhabit our planet; to understand that it's at best difficult to predict, let alone observe, phenomena that is ultimately influenced by our own participation in it. 

I.e., it's the attitudes, the desires, the greed, the fears, the whims of humans at any given moment that ultimately determines pricing -- be it of Tesla stock (which utterly defies any conventional valuation model) or cherry tomatoes -- within the global marketplace. 

Hence, our ongoing, and painstaking, analysis of the data that inform us on what people (consumers and producers alike) are doing, where they're spending their money and allocating their resources, whether or not they're working, and how they feel about their present lot, as well as their future. And, perhaps most critically, when it appears as though their collective psyche has pushed stock prices further (in either direction) than what the data suggest their direct experiences justify.

With regard to the latter, the fact that we've all witnessed firsthand how folks can act irrationally, how, contrary to conventional economic thought, they don't always act in their own best interests -- how, therefore, their thinking is all-too-often the definition of inefficient -- entirely proves that markets are inherently anything but efficient. Academia's unwillingness to accept this reality speaks to the human mind's need to make perfect sense of things. Better, and safer, when it comes to the financial markets, to resist that need!


Lastly, speaking of how folks (specifically you readers who happen to be our clients) feel about their present lot, we'd like to borrow the final paragraph from the "Our Purpose" page of our own website:

If our clients live their lives in comfort, if they go about their days without a financial worry, without reacting to or fretting over the inherent volatility of financial markets — if our commitment to them instills, or enhances, that sense of wellbeing — we are indeed successful as a firm.
Thank you for reading!

All of us here at PWA wish you and your loved ones a Happy and Prosperous New Year!




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