Have you ever played with a Magic 8-Ball? For those who aren’t familiar, a Magic 8 ball toy is a silly fortune telling device that would give you random “Yes” or “No” answers to your questions. The part I always found endlessly hilarious was the Magic 8 ball would also give non-committal answers like “Cannot Predict Now” or “Concentrate and Ask Again” or “Reply hazy, try again later.” Think about it: this toy has no other function than to provide a random answer, but it still finds a way to be ambiguous and hedge its bets, as if this toy is absorbing more information.
I think about that toy when I consider the investing consulting aspect of our business.
In the long term, investment consultants could navigate through choppy markets by operating within the trends and historical relationships between risk and return of differing asset classes and investment strategies. Investment consultants could provide prudent financial advice based on these long term trends and business cycles. In the short term, prediction is terribly imprecise because there are unpredictable and unknowable factors that influence the market constantly.
For example, a client who is receiving advice might ask, perfectly reasonably, what a certain stock will do, or which direction the market will go on any given day. The joking response to these questions is: “I left my crystal ball in my other suit jacket”. Investment consultants do not focus on day-to-day market fluctuations as investment managers do. Certainly, investment consultants are often called upon to objectively interpret the performance of the investment managers, so understanding the managers’ biases and style relative to markets is critical. Furthermore, depending on the type of client and the scope of the agreement, an investment consultant may have tactical leans or biases in investment manager types (e.g. fundamental, quantitative shops, contrarians) that all have short term effects. But generally speaking, investment consultants focus on the big picture. In other words, most investment consultants emphasize long term strategic goals and largely ignore the short term market uncertainty as temporary noise.
The problem occurs when the market uncertainty reflects a sea-change that fundamentally shifts the long term trends that consultants depend on. Are the trends stable or is the uncertainty growing? We note that the uncertainty plaguing the market has measurably gotten worse over the past decade because the scope of the questions have gotten larger.
A decade ago, our questions were limited to the leverage and overreach of the technology sector in the “dot-com” crash, but there was a self-effacing acceptance of the overreach. In the wake of the 2008 financial crisis, we worried if the overreach of the financial sector would freeze up the capital markets to the extent wherein ordinary, solvent businesses would collapse due to illiquidity.
A decade ago, we worried about individual, specific companies that were embroiled in accounting scandals. Today, we worry if the continent of Europe can support its experiment in monetary union without fiscal enforcement.
A decade ago, we wondered if irrationally exuberant investors had relied too heavily on the “Great Moderation” and if the markets were begrudgingly due for a downward sliding correction. Today, we worry if the overarching debt structure of the United States has been overextended to the point where the fundamentals of the market switch to a “New Normal” of low growth, a generation of deleveraging, and muted returns.
Today’s issues are macroeconomic and they threaten the long term expectations of investment consultants who base their advice on historical relationships of risk and return. (In a sense, the fiduciary guidance we provide is clearer function because it is explicitly defined by the law or implicitly supported by long standing principles.) Balancing the evidence and constantly evaluating the long term trends and their potential for change informs our consulting work.
What’s our outlook given the evidence? “Reply hazy, try again later”