John Maynard Keynes is a British economist credited with this quote in the 1930s. Over the years, I have written about evaluating investments through the quality of the business and the price we are willing to pay for it. Sometimes, as investors, we have to evaluate investment decisions beyond these fundamentals. Sometimes that requires admitting we are currently wrong and need to shift gears.
We can all thank Keynesian economics for low interest rates and government stimulus in the face of increased unemployment and recession. He pioneered the thought that demand influences prices more than supply. The quote above references the fact that there are market forces that can drive returns beyond what may be viewed as rational values. He believed that government intervention could help push economic forces in a more positive direction to help support employment and economic growth. Arguably, this theory has helped insulate recessions over the past 20 years from becoming all-out depressions.
I started in the investment business in 1997, just a few years prior to the technology bubble burst of 2000. In 1999 I started as an analyst for what was heralded in the 1990s as a prominent value fund. Value funds seek investments in quality companies that are selling at a price lower than the estimated value (think Warren Buffett). In contrast, growth funds seek investments in companies whose earnings are expected to increase at an above-average rate compared to their industry sector or the overall market.
1998 and 1999 were not attractive years for value investing. Every high-flying growth technology company employee was dreaming of retiring before the age of 40, and general investors were shunning traditional companies in the face of new technology geniuses such as pets.com. Billions of dollars flowed from value investments to growth investments, driving many value funds out of business. Warren Buffett was generally viewed by many as an old coot who couldn’t keep up with the times.
Although the investment group I worked with lost more than half of its assets as money flowed to growth managers, the fund stayed in business through the technology bubble growth and burst. As technology stocks plummeted in value in 2000 and 2001, the stocks in our value funds held up much better and far outperformed the bubble-bursting growth stocks. Relative performance was strong again.
So, billions of dollars flowed right back into the fund as investors who left acknowledged they were wrong. Right? Umm, no. It just doesn’t work that way. Money eventually flowed back into value funds. However, never at the significant rate, it moved out. And, most likely those investors moved back to value funds after value funds booked significant market gains. Just as many of them moved into growth stocks in 1999, after these stocks had made most of their money.
So, what lessons did I learn from this early in my career?
- This happened with growth stocks that were priced well above their value, and with the value stocks that were priced well below their value.
- Although future investments may pay off in the long-term, short-term losses can be much deeper than ever anticipated.
I’m not a big fan of admitting I’m wrong. Maybe you can’t relate. But, in general, I don’t think any of us like to admit it. Being in this business for over 20 years, the other lesson that every investment manager learns is that the market can be more humbling than we like to admit. All we can do is evaluate our decisions and try to understand what we did right and how we can improve our thinking.
There have been many very positive investment decisions over the years that have added to client values. But, sometimes cutting the cord on an investment that hasn’t worked can be a very good decision.
A trade was made in client accounts on October 1st to sell all direct holdings in the energy sector and purchase a consumer staple ETF with the funds. For over five years I have evaluated large energy stocks, such as Exxon Mobil and Chevron Texaco, as selling at stock prices that are far below their respective value.
I remain steadfast in my belief that these large energy companies came into the oil price downturn with enough cash and company strength to weather a sustained low price in oil. I also believe these companies are investing in “green” technologies and have the size and strength to capture this market when it is economically viable to do so. And, oil and natural gas will still be a staple for global energy needs for many years to come. Current stock prices reflect continued, significant degradation in earnings value that may or may not be realized.
What I believe was significantly underestimated in my research was the impact of the “green energy” movement perception on investment flow. Socially responsible investing (SRI) has had a powerful impact on investors and the companies they are looking to invest in. Environmental protection has become a hot topic for many large investment organizations. I believe that for all the positive flow “green energy” companies like Tesla have received, the large energy companies have seen negative flow.
How long can this last? According to Mr. Keynes, we could see this trend for much longer than may seem reasonable from a valuation perspective. At this time it doesn’t seem prudent to fight the SRI wave and continue waiting when there are other perfectly good investments we can take advantage of.