The most prosperous investors do not achieve success by always being right, but rather they do so by being able to recognize and accept when they are mistaken. For example, Warren Buffett is considered to be the greatest value investor of all-time because he stays in an investment when his thesis is correct, but more importantly, he gets out quickly when he realizes that an idea has turned against him.
The Investment Committee remains very bullish on the overall direction of the U.S. economy and equity prices over the next several years, however, we regularly inspect markets to determine where potential risks may lie so that we can properly position our portfolios.
In order to maintain this impartial approach to investing, we conduct rigorous analysis to identify the positive aspects of our economy (“tailwinds”), and then weigh them against the negative ones (“headwinds”).
Since economies are inherently cyclical, there are times when the good outweighs the bad and vice versa. The key point is to always analyze the positive and negative data before making a call on way or the other.
NOTE: This process prevents us from “putting the cart before the horse” and avoids some of the behavioral finance biases that entrap investor into first stating a conclusion and then going to look for evidence to support.
In doing so, we see a number of headwinds to our economy at the moment:
The next step is to quantify the tailwinds to the economy as well as their expected duration, much as we do for the headwinds. Here are a few of the more notable tailwinds that we believe will drive our economy forward for the next decade:
The final step is to determine if the headwinds outweigh the tailwinds or vice-versa. Think about riding a bike in downtown Chicago, which is a city known for its high winds. There will be days when the winds will be so strong along the lake that riding a bike may be near impossible, but there will also be days where you can still get around if you put a little more muscle into your ride.
This analogy is precisely where we see our economy as we enter the second half of the year. Although there are negative forces within our economy, we believe that the tailwinds are not only stronger but will persist for much longer than the headwinds.
Implications for Investors
Economies are rarely so strong that they feel impenetrable to a downturn, but the two most recent time periods that match this description are worth noting:
Ironically, the times when economies are “white hot” and their pace has created exuberance that is pervasive across all sectors, as they were in the examples above, are the times when investors tend to miss or simply disregard the headwinds.
NOTE: Remember what happened to our economy in 2000 and 2008? These two most recent recessions coincidentally occurred right after the aforementioned periods because we had peaked in our economic cycle, and exuberance in conjunction with overconfidence made investors feel invincible.
Furthermore, surging economies are almost always met with action from the Fed to cool things down. Although we see the tailwinds overpowering the headwinds for some time, we are nowhere near these examples above. Hence, we see very little risk of any near-term action by the Fed to slow our economy down either.
The bottom line is that waiting for all headwinds to dissipate will typically prevent an investor from realizing most of the gains in an economic expansion. The reason for this paradox lies in the fact that economies without headwinds are usually those that are peaking or have peaked. We strongly believe that we are several years away from a top in this economic cycle and remain confident in our forecast for a slow and steady rise in equities over the coming years.
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