By Larry Whistler
Pur·ga·to·ry – (in Roman Catholic doctrine) A place or state of suffering inhabited by the souls of sinners who are expiating their sins before going to heaven.
For those of us that received the bulk of their early education from the likes of Sister Mary Payattention!, not to mention the brilliant but stern Jesuits of my high school years, the concepts of Heaven, Hell and Purgatory are firmly established in our collective psyche.
Heaven and hell were easy enough to grasp – strive for one, definitely avoid the other, but purgatory was always sort of that nebulous place where we all knew we had to spend some time, but wasn’t so bad. Kind of like a Comfort Inn when you’re on a family road trip with the kids.
There may even be an indoor pool to help pass a couple hours, not to mention the “free” breakfast. As the more formal (“formal” meaning the first hit I got on the internet) definition above states, purgatory is that place where we atone for our sins before meeting up with St Peter at the pearly gates, when our true fate will be revealed. It could be that we’re in this temporary holding area for a ew weeks, months, maybe even years. It all depends on how much we learned and lived the teachings of Sister Mary and others.
Unfortunately, I may be in for an extended stay. My early Catholic school challenges aside, I think it an apt metaphor for where we find ourselves on the investment landscape today. It’s definitely not a great environment to make money, but far from the worst. We’re likely to be here for a while, but not permanently. And where we ultimately end up probably depends more on what we do now as opposed to what we’ve done in the past (unlike the real purgatory).
The challenges investors face today primarily include uncertainties around Brexit, the Fed and China. These are three huge macro variables that could each determine our near-term investment fates, and collectively likely will.
The tough thing is that there is no easy or quick resolution to these issues and truly only time will tell. That’s a pretty tough pill to swallow for investors with money on the line, not to mention retirements, college educations or homes to buy.
So, what should one do while biding their time in this investment purgatory? In our view, the three most critical choices investors can make today in order to improve their chances of passing through St Peter’s gates are: 1) Be patient, 2) Be realistic, and 3) Be opportunistic.
I know it sounds simple, but when your neighbor is bragging to you about how his utility stocks are up 24% this year (but doesn’t mention their ridiculous valuations), it will be hard not to want to jump on that train. And if you’re a pension fund trustee banking on an 8% annual return from your 60/40 portfolio over the next 7 years, all we can say is good luck! But don’t check out completely because with volatility comes opportunity, and the successful investors over the next few years will need to be ready to take advantage of market dislocations and mispricing’s. Patience The idea behind the Christian purgatory is to atone for one’s sins.
The investment sins we’re atoning for involve excessive borrowing over the past 20 years and pulling too much spending from the future back to today. Hence, the weak economic growth we’re experiencing now. Following the bursting of the credit bubble in 2008, household debt has declined as savings rates have increased (a negative for GDP), while both corporate and government borrowing rates have increased.
It would appear that the cure for too much debt in 2008 has been more debt. Granted governments are generally better equipped to handle excessive debt versus ordinary individuals; however, the debt/GDP levels in many countries (i.e. China & Japan) are alarming. While we don’t anticipate another ’08-like crisis, the “secular stagnation” thesis is becoming more base case than previously thought. Investors will likely be rewarded for resisting the temptation to reach for return while sticking with their long-term plan. No overnight fortunes will be made in this environment, though many investors will be just fine.
Be Realistic (or Penitent)
Since 2008 investors have bid up the prices of virtually all financial assets to a point where future returns are bound to lag. Equities, bonds, real estate and collectibles are all expensive by historical comparison. At Nottingham, we steadfastly believe that starting point matters.
What you pay for an asset today has a huge impact on the future return one receives from that asset. Take the table below for example. Using the Shiller P/E (a price/earnings ratio is a rough valuation measure for equities – what an investor is willing to pay for a $1’s worth of earnings.