How to Walk Through Perilous Situations
December 27, 2017
One of the biggest influences in our investment methodology is not just Ben Graham’s “The Intelligent Investor” but Lao Tzu’s “Tao Te Ching” as well. The Way of Life is not really a finance book but is about Taoism. It is a philosophy that brings us peace time and time again. Lao Tzu was a librarian during the 6th century BC in China. Upon reading a lot of books, he became enlightened and figured out how to achieve peace and happiness. He was even admired and was called the “Dragon” by Confucius. Lao Tzu wrote the Tao Te Ching and disappeared to live a life of solace. This book gave me advice and comfort after being displaced by the Asian financial crisis. From nothing comes something, and something has come time and time again.
One of my favorite lessons is about invisible threats. One third of people live long and healthy lives; one third die premature deaths, and another third would have lived long and healthy lives if they did not cause their own premature deaths. A person who values life can walk through a jungle with vicious and poisonous animals and come out unharmed. A snake bite is deadly, a rhino’s horn is pointy, and a tiger’s claw is sharp, but these do not harm him. The same person can go through an active war-zone and come out unscathed from the sharp and pointed weapons of the warring combatants. Why is it possible for a person to come out of these dangerous situations alive and well? It is because a person who values life will not put himself in a perilous situation.
This holds true as well in value-investing. There are a lot of dangers in the stock market. There are economic downturns, negative company developments and others. Aside from these, the value-investor has to be alert of invisible threats that directly affect him. These are irrational exuberance, pride, idleness, diffidence, herd mentality and other invisible threats that will corrupt his decision-making. To avoid these, one has to nurture life or in this case, nurture the fund that he is responsible for. Nurture it to have minimal risks, a wide moat and sustainable growth no matter how perilous the investment environment is. There are many correlations between the Tao Te Ching and Value-Investing, and this lesson is one of them.
As the S&P 500 breaks through new highs, we see a lot of red flags. As markets get enthralled by Bitcoin and other crypto-currencies, the S&P 500’s Cyclically-Adjusted Price to Earnings (CAPE) ratio just passed its September 1929 high. This is right before the Great Depression and is the S&P 500’s second-highest peak. Its highest was right before the dotcom bubble burst of 2000. The S&P 500’s CAPE ratio is far from its euphoric all-time peak, but it is already a concern. We also saw a market reversal for the PSEi last All Souls’ Day. The economy is doing great, but we see an asset shift from stocks to bonds that will rationalize the PSEi and ASI. Growth is already priced-in heavily, and earnings have a long way to catch up. These red flags are perilous situations investors can walk through by adjusting their stock portfolios.
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