It was a good year for AUTHENTIC’s Clients. We enter 2018 forging ahead with our current strategies.
For greater constructiveness and a better balance, we are informed by the following learnings from last year:
1. Longer equities
One feels like a real chump hedging rampantly rallying stock markets in a low volatility environment. Without stock market setbacks to actively work from, cautionary tactical hedging translates into longer periods of reduced market exposure – with substantial return-reducing consequences. The lesson learned the past year was that the vortex for investment performance was being outright long equity markets while financial conditions remain loose. Illustrative evidence can be found in the performance of the Credit Suisse Hedge Fund Sub Indices1. The overall broad hedge fund index only delivered 7% one-year performance (through Nov. 30, 2017), about half a percentage below the long-term average, and well below equity markets. Strategies with breadth of activity beyond just the equity asset class, had a particularly tough time. Both global macro and managed futures delivered performance of just 2%. Even with the increasing price dispersion across sectors, equity market neutral strategies only eked out a 5% return, just 1% above the long-term average. While long/short equity strategies have greater opportunity to deliver performance, keeping up with the total return of the stock market will remain elusive, as long as this type of strong run-up in equities continues.
2. Shorter interest rates
The mandate of developed central banks of targeting the rate of consumer price inflation, is woefully disconnected from overall financial conditions. By boldly erring on the side of keeping interest rates ultra low, asset price exuberance in the equity and real estate markets is in full thrust.
At AUTHENTIC, our sense is that the dominant central bankers are gradually corralling each other towards monetary policy tightening as a more synchronized global affair. We should have greater confidence that interest rates have bottomed and will tend upwards, at least in fits and starts. Last year we learned that there is a payoff to tactical short positions in interest rates. Looking ahead, it makes sense to somewhat intensify these initiatives.
The primary challenge is one of market perception towards impact. In hindsight, our perspective last year on the US Federal Reserve was overly cautious; the market took their 0.75% increase in stride. How should one interpret the US Fed hiking official rates by 1.5% over the next two years? While this amount doesn’t appear to be all that much, it would represent a doubling in short term rates from their current level! This makes our caution difficult to shake. At some point, rising rates will introduce a negative feedback loop into the equity and real estate markets. We must also cast a watchful eye on “macro-prudential” measures of other government agencies aimed at curtailing foreign investment and asset speculation.
3. Better connecting the dots between currencies and stocks
We tend to pursue the reverse of the home bias. In other words, we often perceive the grass as being greener elsewhere. This outlook can serve us better. In particular, we will strive to do a better job connecting the dots between currency and equity exposures. Here are three examples. We like Europe. They are restructuring in numerous ways and means that seed positive longer-term dynamics. We have European equity exposure but not enough euros. We like Japan. Corporate profitability in their advanced industrials and technology is accelerating. We hold yen but are insufficiently invested in Japanese companies. We like the US. They progress high growth technologies with corporate oriented government policies. We have stock holdings but perhaps too many US dollars.
4. Balanced exponential mindfulness
Ringing in the New Year at AUTHENTIC, we redouble our efforts to be mindful of exponential potential, while careful of the hype. Digitalization and widespread access to stores of knowledge and big data, turn traditional economics of scarcity on its head. The virtual network opens the world to a new realm of abundance through economies of scale. Adoption rates for products and services can now swiftly extend to a significant portion of the entire world population. There is an ephemeral balance somewhere in that realm of investments in companies with good, versus those with exponential, potential.
Our lesson from last year is one of overly sober assessments. We held back from investing in some high potential companies because they seemed too darn expensive. Yet exponential growth is the stuff dreams are made of. If a $25,000 investment in year one, were to double in value each year, just guess how much would it be worth in year 14? The answer: a cool $200 million. However, there’s a couple of catches. Exponential projections are prone to substantial forecasting error. Furthermore, market capitalization is a simple, valuable, and yet often overlooked, measuring stick. If the stake was initiated when the company was capitalized at just $900 million, then the corresponding market capitalization (without dilution) in year 14 computes to $7.4 trillion. That’s the current equivalent of 4 Facebooks, 4 Amazons, and 3 Apples, all after their strong recent advances, and all combined!
At AUTHENTIC, we are excited by the investable realm of the possible, and yet grounded by the reality checks of the probable. We aspire with these lessons to be singing along a year from now to a modern Michael Bublé version of Sinatra’s iconic “It Was A Very Good Year”. In the meantime, all the very best!