Review & Outlook

Our take on the investing, financial, & economic themes of the day

Reflecting on the Culture of Investing

11 October, 2016 by Mark O'Brien in Commentary


The occasion was a luncheon in the mid-1980’s at the Union League Club of Philadelphia, followed with a talk by Sir John Templeton, the great investor and benefactor.  After a short talk, Sir John took questions, the first of which was his best investment idea for making money.

I was a member of the audience and can say that I was sorely disappointed in the answer, for I was then a young man in a hurry, newly out on my own as a money manager, and hungry for investment ideas that would make money—preferably a lot of money—for my clients, and thereby help me attract new clients and build a larger investment-advisory business.

“My best investment idea for making money?” replied Sir John.  He paused.  He surveyed the room.  He took more time.  The luncheon guests shifted in their chairs, pens at the ready, the air crackling with anticipation.  Sir John looked into the faces of those present, studied them, and after a long time said, “My best investment idea for you, for each of you, is to tithe.”

To say the air went out of the room would be an understatement.  I can confidently say that most of those present were not familiar with the word, much less with the ancient practice of each year giving a tenth of one’s income to charity.

Sir John went on to answer other questions in a more conventional manner, responding with comments on then-current and likely future interest rates, the prospect of inflation, trends in employment, and other measures regularly considered in the trade of investing.  Many years later, however, and nearing the end of a long investing career, I return to Sir John’s answer.  He was clearly on to something that we as individuals and as a society forget at our peril: that investing is, first, an act of culture.  Habits and practices, shared understandings of ethics and morality, must be in place before people will be persuaded to give up something today in return for the prospect of even more tomorrow.  Ownership of private property and the rule of law are often cited as preconditions, but no less important are personal qualities (or are they virtues?) of trust, patience, hard work, enterprise, thoroughness, consistency, the need for planning, and resistance to believing in fables–like getting rich quick.

The conclusion is that managing a portfolio of stocks and bonds is often the easy part.  More difficult, and always more important, is the process of learning how to recognize and then adopt the habits of mind–the culture if you will–in which successful investing can take place.

Practicing Patience With the Market at an All-Time High

28 July, 2016 by Ben O'Brien in Commentary

Recently the financial press trumpeted that the S&P 500 was at a new “all-time high.” In one sense this is a good thing, a sign of strength and resilience, that the market has recovered from the financial crisis and is breaking new ground. In another sense though, many stocks are getting expensive and bargains are harder to come by than they have been in a while.

In markets like these, patience is key. Seeking out reasonably priced, high-quality stocks is essential because you can’t rely so much on market wide “multiple expansion” which is the rising tide that sometimes lifts all boats.

Warren Buffett has said that success in investing is as much or more about temperament than it is about intelligence or expertise. In today’s uncertain market, we believe avoiding panic and cultivating virtues like patience and discipline is of more use than the financial or mathematical jujitsu practiced by Wall Street super geniuses.

Buffett’s right hand man, Charlie Munger once said, discussing the record of Berkshire Hathaway: “If you took our top fifteen decisions out, we’d have a pretty average record. It wasn’t hyperactivity, but a hell of a lot of patience. You stuck to your principles and when opportunities came along you pounced on them with vigor.”

Patience has been on my mind a lot recently. I am waiting for a number of things, not least for my first child to arrive, due on September 10th. Reading a book about parenting I learned that, according to one school of thought at least, cultivating patience in a child from the very beginning provides the underpinning of everything in his or her development from sleep to eating to communication. The book cites a famous study at Stanford in the 1960’s and 70’s where three-year-olds are given a marshmallow and told if they don’t eat it until the adult comes back in a few minutes, they will get another one. Most kids can’t resist. They eat the marshmallow almost immediately. But for the ones who don’t, this display of patience is correlated with all sorts of success in life later on.

Forgoing present gratification for the sake of much greater benefits later is what investing is all about. A recent column by the economist and blogger Tyler Cowan highlighted the larger crisis of impatience in American society. He argued that the discontent among large portions of the electorate today is linked to the retirement crisis and lowered living standard that has resulted from the sharp decline in the saving rate over the last 30 years. This impatience, Cowan notes, is just as much present is public sector—unfunded pensions, fiscal deficits, etc.—as it is in households.  As a society we have spent several decades eating the marshmallow.


Source: Bloomberg

The study mentioned above found that the children who successfully passed the test were the ones who found some way to distract themselves, twiddling their thumbs or playing a little game. Those who stared at the marshmallow invariably ate it. At O’Brien Greene our way of distracting ourselves from the irrational mood swings of the market is to spend a lot of time on the analysis of individual stocks. We try to understand each business, its management and its industry and evaluate its future cash flows as well as the durability of competitive advantage.

If you really know your stocks, it’s easier to hold on when the market and the media are seized by fear. You know that even in the worst of times people will still do Google searches or drink Coke, and so companies that make these essential products will continue to generate strong cash flow.

I met a guy recently who works at a successful Buffett-style investment firm where he says some research analysts will go for a whole year without recommending a single trade. Some people find it boring, but their performance is very good. The key is during this period of apparent inactivity you need to be actually building up a base of knowledge and an extensive watch list so that you can decisively spring into action when the opportunity finally arises.

When it comes to investing, patience pays. Don’t eat the marshmallow!


Big U.S. Banks & Brexit

25 July, 2016 by Paul Devine in Commentary

Two of the largest U.S. banks reported their second-quarter earnings late last week, and while the earnings were as moderately strong as most analysts had expected, it was surprising how little attention was devoted to the Brexit both by bankers and analysts.  That’s not surprising, since most of Brexit’s implications are about the future, while second-quarter earnings are about the past, before Britons voted at the end of June.

JPMorgan Chase reported on the 14th that net income of $6.2 billion was for the second quarter was 10.9% greater than the first quarter, although “relatively flat compared with the prior-year quarter”; the first quarter had included a number of special charges, and merely matching the same-quarter-prior-year’s profit counts as a good result in the current banking environment.  The next day Wells Fargo reported 2Q16 net income of $5.6 billion, essentially its profit in the same quarter of 2015.  Wells’ strong growth in loans, deposits, and revenues were in part offset, management said, by $924 million in charged-off loans and a $150 million increase in reserves for future loan losses, which together should insulate the bank from any further earnings impact on its portfolio of energy loans.

Two very large but different U.S. banks (Morgan views itself primarily as an investment bank, while Wells concentrates on retail banking) thus reported  results better than what most analysts expected.

JPMorgan Chase’s chief financial officer told analysts that the bank had done well despite the Brexit because it had prepared as thoroughly as possible for a “Leave” vote and because it earned fees helping European commercial banks—particularly in Italy and Spain—deal with the market upheaval that followed the news.  One analyst asked the CFO if there would be operational or legal issues that might emerge, and she responded that it’s too soon to tell, but that the bank would continue to support its clients; CEO Jamie Dimon said “there is a range of outcomes” that will not be determined for years, but that JPM is “not going to pull back on serving” European clients.  Another analyst asked if Brexit changed the outlook for M&A, and the CFO replied that generally uncertainty discourages acquisitions, but “at the end of the day” there “would be a tailwind” for M&A.

Wells Fargo’s CFO told analysts that the bank had benefited from buying early in 2Q16 investment securities with “interest rate levels above those available later in the quarter, after the ‘Brexit’ vote.”  The “biggest impact of Brexit was not on how we do business,” the CFO said, “but the big move down in long-term rates.  It’s a great time to be a borrower.”   One analyst asked about Wells’ prospects for its Commercial & Industrial lending division, whether there were Brexit concerns.  The CFO responded that he was “not sure what would build certainty among businessmen” but that while C&I is “not as vibrant a sector as it has been at other times,” that placidity reflects “seasonal or short-term factors” and that “there’s no big story there.”

After all the fuss in the financial press in advance of the British referendum, the surprise victory of the Leave advocates, the brief spasm in financial markets, and the downfall of a Prime Minister, the event which three months ago everyone expected would shape the quarter’s market results turns out to have been a non-event for large U.S. banks and almost all U.S. individual investors.

Will it continue to be immaterial?  It’s hard to say at this early date.  But there’s one small piece of evidence that Brexit won’t be so bad for the future:   In the days after Brexit the Wall Street Journal reported that Wells Fargo took advantage of the pound’s weakness to buy a new office building for £300 million—in the heart of the City of London.

Puerto Rico to Default Today

Two years ago, almost to the day, I wrote about the Puerto Rican debt crisis and how mutual funds had foolishly loaded up on high-yielding, risky Puerto Rican debt.  Thus investors who thought they owned, say, Virginia municipal bonds, actually had 50% or more of their assets in Puerto Rican debt.

The WSJ reports today that the island will officially default today:

Puerto Rico will default on its constitutionally guaranteed debt for the first time Friday by failing to make most of some $1 billion in payments due, officials said on Friday.

The island’s Government Development Bank said the territory faces an imminent cash crunch and that its cash balances have dropped to “dangerously low” levels. As a result, the government isn’t likely to make any of the $779 million payment on general obligation bonds due Friday.

“Even if the commonwealth were to devote every last penny” in its operating account to Friday’s debt payments, “it would still owe holders of the public debt hundreds of millions of dollars,” the GDB said in a statement.


Buying Opportunities from the Brexit Sell-Off

U.S. markets have been up strongly yesterday and (thus far) today, as have British and European markets.  Are there buying opportunities among the stocks that sold off sharply on Friday and Monday?

Fewer than you might think.  The selling on Friday and Monday wasn’t indiscriminate, and it’s indiscriminate selling that creates opportunities.  Not everyone understands this, including the headline editors at the WSJ.  Consider the curious subtitle from a WSJ piece the other day by Spencer Jakab titled “Are There Bargains Among the ‘Brexit’ Wreckage?”.  The subtitle read, “Not all stocks were equally hit when the U.K. voted to leave the European Union, but that doesn’t necessarily mean a buying opportunity.”  The implication is that an unequal stock sell-off would mean that there were buying opportunities.  This seems exactly backward: if stocks were equally hit when the U.K. voted to leave, then there would be obvious buying opportunities, because stocks’ fortunes aren’t equally implicated in Britain’s EU membership.

Here’s a snapshot of the hardest-hit large-cap London-listed stocks from Friday:

FTSE losers

As I noted yesterday, there was a clear predominance of financial services companies. A fair number of stocks in the FTSE 100 were up on Friday:

FTSE winners

The S&P 500 Index sold off, but as you can see from the dashed line below, it dropped back only to its level in March, which is a point where many companies were still near their 52 week highs.

s&p 500

As in the UK, financial stocks in the US sold off the most during Friday and Monday’s declines.  The sell off might be merited in big global banks, but it’s less clear why small-cap US banks or financial technology companies like S&P Global (SPGI) should be punished.  These are the sort of limited opportunities we’ve been considering.