We believe that investing in shares and property isn't about focusing on individual companies and property assets, what we can call "micro" factors.
- Geographical location of properties, rental returns and historical capital growth.
- Charting, technical analysis and other graphing techniques.
- Financial analysis, which involves studying ratios such as price earnings, book value and other valuation methodologies.
- Risk analysis, which involves studying volatility measurements like correlations,variance and standard deviations.
We think that the micro analysis of shares, property and other assets at a point in time, are at best an indicator of relative value. For day to day analysis, this might be sufficient but for long term investors, these tools are inadequate. Why?
- In this space, you are competing with every other investor in refining research techniques, probably resulting in minimal gains for your efforts.
- Micro analysis studies historical information, containing some useful information, however it is unable to reliably inform you about future economic conditions.
Whilst we agree that some mathematical models can work in the short run, in our experience, the greatest opportunities lie in understanding human behaviour. Specifically, the motives of investors, regulators, businesses and Government.
Understanding group behaviour
We observe that most people have profit maximisation motives, which tends to evolve into excessive speculation over time and then eventually misguided Government attempts to control economic and market outcomes.
For example, George Soros, explains in his theory of economic reflexivity, that rising prices of assets, of itself, encourages excessive speculation with borrowed money. Some call it gambling and greed, others use the term "keeping up with the Joneses". Whatever it is, we have observed its effects in the marketplace.
Many of the participants themselves are completely unconscious of their collective actions on asset prices and the market itself.
For us, this means that many participants are follow trends, which translates into opportunities for the astute to avoid being caught up in market frenzy.
The Big Picture
For us, the Big Picture is dominated by macro factors:
- One of the most important factor is macroeconomics. Understanding how economies work, what drives it and how debt levels affect the economy.
- Another is demographics, which covers aging, generational change, population growth and related issues.
- A third one is politics. Special interest groups may have disproportionate influence over Government decisions.
- Business interests. This is an extension of economics but at a business level. Large corporations are inherently self interested to protect and expand their businesses.
- A major macro consideration nowadays is the environment and climate change. Whether it is man made or otherwise, it deserves serious consideration because it has serious financial implications. Also linked to the environment is the increasing scarcity of natural resources, specifically water and oil.
We're sure there are more macro issues to consider. The point is that these big picture issues have far greater impacts on asset values compared to just using micro analysis to determine whether a company or property is a "good asset".
Evidence for the macro view
- From 2002 to 2007, property valuations globally in developed nations increased in lockstep with increases in private debt levels. Asset values have grown faster than wages. The only way this can happen is if debt levels rise.
- In the 1930's, the Great Depression was caused by the collapse of a large debt bubble, which destroyed many banks and impaired the credit engine of America. It was far more important to understand why share prices rose in the 1920's than to understand the value of individual company stocks or the fact that shares rose in value up to that point.
Perhaps investors are too fixated on micro issues to notice the macro but this could be why large asset bubbles can exist even when a sharemarket is supposed to be "price efficient". That is, when the entire sharemarket is overpriced (or underpriced), the majority of investors don't notice. Essentially, we can expect herd like behaviour to exist and this is exactly what we observe in markets today.
Stepping out is hard
So, the question is: How can you remove yourself from the herd? It's a difficult step to take because the influence of crowds is overwhelming and for most people it means rejecting what they consider "normal".
We believe that in the long run the value of understanding macro issues is more valuable than focusing on micro issues.