Investing is a tug of war between fear and greed
Though the players involved may change from one generation to the next, investing at its core is, and always will be, a tug of war between fear and greed. Fear summons the wanton selling of assets without regard to value, a scenario that often allows us to purchase assets from panicked sellers at a discount to intrinsic value. Conversely, greed creates reckless accumulation, also without regard to value, and makes it easier to find a buyer at prices higher than we paid to the frightened seller. Fear gives us an “in”, while greed gives us an “out”.
At the moment, the side pulling the “greed” end of the rope would seem to have the momentum, so we have been feeding them some of our slack. Rest assured however, that this is a tug of war that never ends. While we don’t know when it will happen, the tide will eventually turn to “fear” in the future, just as it has in the past. At that point, we will rise each morning and put our well rested muscles to work by once again actively deploying capital.
Our view on volatility
The VIX Index, a measure of volatility depicted in the chart below, could be described as the market’s mood ring. When investors are fearful, the market becomes more volatile and the VIX increases. In 2005/06 the VIX reflected a dangerous complacency that set up the financial crisis in 2008-9 which propelled the VIX to a record high that exceeded 80, and ultimately produced another great buying opportunity. In short, volatility is our friend, but it hasn’t shown its face over the past year. The VIX currently trades not far above its historic low and, as one should expect, we find fewer occasions to commit capital.
What this means for equity valuations
The last time we significantly increased our invested exposure was in mid-to-late 2011, when the VIX was rising. The market has increased 40% since then, but not because of business performance. In this weakest of economic recoveries, the S&P 500 earnings have grown just 7.6% since September 2011, so most of the market’s move can be attributed to multiple expansion. We believe it is impossible for the stock market to continue to increase at a significantly faster rate than earnings. Those who remain fully invested have made an implied bet that the world will tilt towards inflation. Although we find it hard to argue that point in the long term, over shorter periods of time that may not prove true. Deflation might rule the day in the months to come, particularly if the Chinese economic engine begins to misfire. We frankly confess that we just don’t know if we’ll have inflation or deflation. And we also don’t know how much of either or when. We wish we could say otherwise.
Those who believe that significantly higher levels of inflation are inevitable, and probably sooner rather than later, would be better served remaining fully invested in risk assets that will help protect against such vagaries that erode cash instruments. On the other hand, those who conclude that deflation will harm those very investments, would be better off keeping their portfolios safely liquid. We have chosen the middle road, a lonely place that offers little conviction in either direction. We therefore maintain a Fund that we believe will not succeed terrifically well in either scenario, but should perform adequately in any scenario.
FPA Investment Philosophy
FPA seeks the broadest mandate. We invest across the capital structure, asset classes, market caps, industries, and geographies.
We are unique because we have an unfettered mandate, we invest on an absolute basis, we consider the macroeconomic environment, and we have a long-term orientation.
We invest our money alongside yours – an alignment of interests we maintain across FPA. We view ourselves as the guardians of the capital entrusted to us and we manage our portfolios in a way that makes us comfortable having our family and friends commit their savings to it. Should our portfolios lag, we will most likely feel more pain than our investor partners.
We view ourselves as pragmatists with a healthy respect for what we do not know. We are neither optimists nor pessimists, as we invariably find ourselves hoping for the best, while preparing for the worst.