Pier Alberto Furno

Outside the Box

Pier-Alberto Furno, CEO at Nemesis SAM Monaco has long track records in Banking industry and Wealth Management. He is Wealth Monaco’s contributor for an “Outside the Box” column. His first article is about the contrarians investors.

Volatility is embraced by the true investor that holds the wisdom of behaving against the crowds.

Early in the year I was attending a social dinner in London and at some point the topic of the conversation, as it’s often the case, turned to financial markets and I was asked what had it been like to live the Lehman collapse, the financial crisis of 2008, the wipe out of the markets in the last quarter of 2018, it felt like a walk down memory lane.

I was asked the question: “what are the lessons you learned; did you learn anything?” Sensing the irony and sarcasm embedded in the question I replied: “I learned that we can never be sufficiently prepared to weather such storms and that investors never learn from previous experiences.”

We are now at the end of Q1 2020 facing the catastrophic effects of Covid-19 both on human health as well as on financial markets. Maybe there is no better time though to take a second walk down memory lane and look at some real numbers:

  • 10/10/07 to 03/05/09 S&P down 56%
  • 4Q 2018 S&P down 20%
  • 03/05/09 to 03/19/13 S&P up 130% back to pre-financial crisis
  • 03/05/09 to 02/19/20 S&P up 400%
  • 02/19/20 to lowest level of the current crash S&P down 35%

Volatility is back at levels unseen since the financial crisis and exactly as in 2008 this volatility was translated by investors through a behaviour characterized by fear and panic and trying to predict the next market move in the hope to time it best and predict the bottom.

During market turmoil as the recent one, characterised by the typical investor’s herd-like behaviour, it’s always helpful to step back to the basics of our investment philosophy and remain focused on what we are really trying to achieve.

I am not going to spend much time trying to forecast the market’s next move for the simple reason that I don’t believe it’s a constructive exercise.

For some reason all analysts and portfolio managers are expected to have an opinion on the future of the stock market. Many of the best analytical brains are constantly engaged in the effort to forecast the movement of prices and I don’t deserve a place amongst them. The trouble with market forecasting is not that it is done by unintelligent and unskillful people. Quite to the contrary, the trouble is that is done by so many really expert people that their efforts constantly neutralize each other and their work comes to resemble a zero sum gain.

A much more constructive approach is to establish a solid investment process based on what we can determine as a company’s intrinsic value and act upon it when there is a substantial gap between intrinsic value and market value.

Intriguingly investors, when faced by extreme volatility and declining markets, behave exactly in the opposite way. They suddenly freeze, adopt a “wait and see” attitude and fear dictate their behaviour.
The explanation of this behaviour can be found through the study of behavioural finance.
A combination of lack of conviction and emotional control are the main drives behind such a behaviour.

The primary source of conviction should be provided by the investor’s analytical work and investment methodology; your process should lead you to a valuation and a conclusion. Nobody in the world can tell you are right or wrong, only time will tell. The crucial factor though is the importance to act upon your convictions: not acting would just be like not having an idea at all.

How often around us we hear “I wish I bought more of this company I just sold the share for a great profit” or “the market is going to go down I should sell out of the market”. Both are true examples of lack of conviction.

In the first I could tell that not enough knowledge and in-depth work was done to be truly convinced in the company, by consequence the investor’s purchase of the stock was rather a speculation than an investment.

For an investor to invest a substantial part of his portfolio (5% or more) in a single stock he must have a deep conviction that can only be provided by a solid round of homework.
Most investors dream of making the quick buck and of being on the right side of the market in the wrong belief that they will be able to get more out of the market than they deserve for the little homework they put in!

The second remark is the consequence of the fact that investors spend too much time listening to the market noise and not enough learning to know better the companies they are invested in.
Here is a non-exhaustive list of some high-quality companies with their performance since the financial crisis: through the sharp 2007-2009 market correction investors would have benefited by these opportunities presented to them by Mr Market:

Microsoft up 1157%

  • Adidas up 1299%
  • Nike up 961%
  • Berkshire up 384%
  • Amazon up 4000%
  • Coca Cola up 200%
  • Lindt up 453%

By holding off judgment until more information, more clarity, more visibility is acquired, they have shifted their focus to the outcome, sustainable economic and market recovery, rather than keep focused on identifying compelling investment opportunities in high quality businesses with high quality management and financial strength trading at discounted level.

This is precisely the time when this gap between intrinsic value and market value can be found and will benefit long term investors. Visibility is something that air traffic controllers need, not for portfolio managers. A big SALES panel is on the front door of the market, but the shop is nearly empty.

As Warren Buffett said:

“You pay a very high price in the stock market for a cheery consensus”.

The panic resulting from falling markets and losses in the companies we hold in our portfolios results from the belief that the market knows something we don’t know. Only a deep knowledge of a company allows one to maintain a healthy distance from markets and embrace the opportunity to buy more of the stock at a lower price.

Let’s not forget that the lower average price always wins provided the company’s fundamentals are well known.
Emotional control on the other hand it’s the ability and mental strength to completely disconnect your emotions often caused by fluctuations. Such an emotional control can only be achieved in parallel with strong convictions and being contrarians.

It has long been known that conventional thinking dominates Wall Street and in fact it is hard to think of a field of human endeavour where non-conventional and out-of-the-box thinking is not successful. This has become so well known in the financial community that a large number of market participants claim to be “contrarians” meaning they take an opposite position from the conventional wisdom.

In reality only a few people really practice this strategy. A popular mistake is to adopt what is considered a contrary opinion, when in reality, it is smack in the middle of mainstream thinking. Contrary thinking requires such independence of mind and disdain of popular opinions that by its very nature it can only be embraced by few persons.
A contrarian’s investor needs to be able to stand alone against the crowds.
The problem is that in our society as John Maynard Keynes said:

“Worldly wisdom teaches that is better for reputation to fail conventionally than succeed unconventionally”.

I would like to ask my old clients if they remember their comments and reactions when we built the positions in Wells Fargo, Salomon Brothers, General Motors, Nextel, Amazon, Bank of America, Citigroup, St Joe to mention a few and I am sure the same disapproving comments will be heard now towards some of our current names.

What I am trying to express through my thoughts is that what I am doing now is exactly what I have been doing in the past: identifying great businesses that trade at a substantial discount to intrinsic value.

The current volatility can only be embraced by investors willing to listen to their convictions more than to the market, be a contrarian and with emotional control, because the market is presenting us with some great opportunities.

The five most dangerous words in the investment business are “…it is different this time.”

Source : Pier-Alberto Furno

Post Author: Wealth Monaco