INSIGHTS

On August 14, 2017

AAM Viewpoints – The Chains of Habit

One of my favorite axioms in its first form from Samuel Johnson circa 1748 goes, “The diminutive chains of habit, are scarcely ever heavy enough to be felt, till they are too strong to be broken.”Warren Buffett has used this several times over the years which is where it often gets its notoriety. I find it an essential frame of mind when analyzing the myriad of data points, market trends and anecdotal arguments that swirl in the world today. It works on both a micro and macro level and constantly reinforces the lyric from Paul Westerberg, “Don’t trade your telescope for a keyhole.”

There are several trends that are the more recent links of habits formed from the onset of the Great Recession and the decade that has followed. The first is incessant search for the next boogey man that has to be just around the corner and ready to pounce for the most worthwhile of reason…or trivial for that matter. For as human understanding has evolved, we are constantly in a state of progression without ever repeating the mistakes of the past…right? It seems we are actually a bit of both at all times as the learning curve (where emotion and logic meet in this example) are never linear.

We have a tremendous amount of psychological and sociological evidence in this, and one very significant economic experience to support the path we currently find ourselves on. The period of the Great Depression was the closest in scope to the last decade. Though the former Treasury Secretary and former Federal Reserve Chairman argued the Great Recession rivaled the severity of the Great Depression, I find that the impact of the Great Depression was far more significant in its depth and breadth.

What we see is the low period of interest rates that lasted until the early 1960s, roughly 2.90% for those 20 years from 1940 – 1962 based on annualized data. Since December 2007 our 10 year has averaged below that period with a 2.59% as central bank extreme actions have pushed rates below a historical natural level.

The decade after the crash of 1929 saw the equity indexes have an annualized negative return of over 5%. The only time this was remotely matched was the decade of 2000-2010 when the annualized return of the S&P 500 was a negative 1%. The decade following the Great Recession has averaged a 12.58% return annually which is well above the decade (1940s) following the Great Depression of 3.02% (price only measured at the time). However the decade following the 1940s saw a 13.5% annualized return. One might argue that the current speed of information and capital flows accelerated what once took 20 years to realize could now be realized in a decade.

One other area of comparison is the low volatility that followed the Great Depression. BlackRock did a study going back to the 1870s and the historic spike was followed a decade later by volatility that appears to mirror the current state.

As such, another chain of habit has evolved that receives quite a bit of notoriety is buying the dip…or for those who are more pressed for time and appreciate acronyms, BTFD. The appreciation level for this habit falls distinctly on which market trend you lean toward; bullish investors believe it is a smart approach while bearish investors see this as apathy and a significant sign of a coming collapse.

We favor the bullish side of this viewpoint and have used it consistently over the last few years in both international and emerging markets as well. The fundamental bullish picture is not only still intact, but has seen perhaps a pick up globally as various indicators show a congruent acceleration among many regions of the world.

With the recent rise in domestic and international risks and uncertainty regarding politics and political stability, we are cognizant of the anxiety of such surprise events and the flight to safety it could lead to. We do, however, see many of these as short-term corrections and not fundamental, and would appear to be corrections within the long-term bull market. While keeping some powder dry may make sense for the most anxious investor, the recent correction in August appears to be a shorter lived one. Some points to consider:

• A recent study by UBS on high net worth investors worth over $30 million are holding an average of 35% in cash.


• According to Bloomberg, private equity firms “are sitting on a record amount of cash they’re struggling to invest” and are sitting on $963 billion as of the end of July 2017. According to an article by Sarah Jones, the massive amount of money means the length of time to deploy these amounts runs out after almost three years.


• The Atlanta Fed GDP forecast now stands at 3.55% for the 3^rd quarter GDP estimate. This corresponds with the recent earnings report for the 2nd quarter, which saw nearly 90% of the companies now reporting.
  
  
  
  

Source: JP Morgan | EPS=Earnings Per Share. YOY=year over year

Past performance is not indicative of future results.

Though earnings growth rate may drop a bit in the second half, we are still experiencing a better macro and earning backdrop than seen in several years. We maintain our bullish stance and overweight in risk assets even with a bit of volatility expected in the short run. 

CRN: 2017-0807-6083 R