Being a fairly regular attendee at church, I enjoy the reflection that comes from listening to our Clergy explain the liturgy in ways that tie our lives, habits and values to what is happening in the world around us. As with most large groups, I expect how the message is interpreted and acted on varies widely within the congregation. As our democracy embarks on a new period of its long evolution, concerns are at a crescendo and opinions on the outcome of issues are not always positive or optimistic. Under this backdrop, our Rector gave what I believe was a thoughtful sermon on how to put the current state of affairs in context while offering ways each of us could move forward in a caring, positive way as individuals. That should not come as a surprise given the role Clergy play in our communities. What might come as a surprise and at the risk of being accused of not paying attention, I couldn’t help but make a connection between the sermon’s foundation – VUCA – and what happens every day in the global equity and bond markets.
Like me before the sermon, for those who don’t know, VUCA is an acronym for words we all know and occasionally use to describe a situation, something we have seen or maybe experienced. During Sunday’s sermon, I learned the acronym originated at the United States Army War College. Further research confirmed the acronym is used to describe various business conditions and serves as a basis for case studies at Business Schools around the country. The latter is not surprising but it would seem a safe wager the War College scenarios are much more interesting.
characterized by or subject to rapid or unexpected change
not reliable, not clearly identified or defined
a group of obviously related units of which the degree and nature of the relationship is imperfectly known
doubtful or uncertain
At the United States Army War College, dealing with a geopolitical VUCA world is at the forefront of strategic planning and education. When listening to the sermon on Sunday, I couldn’t resist drawing similarities between navigating a geopolitical VUCA world and what investment managers do to chart an investment VUCA world. Geopolitical and investment VUCA are similar in that both are unpredictable. Unlike geopolitical VUCA, in the opinion of the writer, navigating investment VUCA is somewhat easier. Business economic and sector cycles that exhibit reversion to the mean and companies that follow generally accepted accounting principles (GAAP) as defined by the Financial Accounting Standards Board can provide historical perspective and definition. The general ebb and flow of economic cycles combined with data transparency can help make reasonable assumptions about what the long term may bring while facilitating decisions on the appropriate allocation strategy for clients with a certain tolerance for risk.
In March of 2009, the Dow bottomed at around 6600. A few days before Thanksgiving of last year, it closed at just over 19000 and last week has reached 20000. The path to this threshold was filled with VUCA and its future course will be too. Late last week the Wall Street Journal highlighted the ascension, noting it took only 42 days to climb the last 1,000 points. This Hussein Bolt like Olympic dash was the second-fastest thousand-point gain in the index’s history, after its 24-day climb from 10000 to 11000 during the dot.com boom in 1999. Some say relatively low interest rates, suggesting a sluggish global economy and expensive valuations relative to historical levels portend a market pullback. Other data point to an acceleration in U.S. economic growth and an improvement in corporate earnings. Are investors to believe the latter and the possibility that corporate tax reform and infrastructure spending will provide a base of support for more growth? Or, should investors be cautious and anticipate a correction after a positive run of 8 years? These are good questions and impossible to answer with any confidence or certainty regardless of business cycles and company data transparency because of VUCA.
Investment VUCA and Portfolios
With few exceptions, reviewing portfolios and 2016 performance has been a positive exercise. More importantly, it has reinforced views on client behavior and how allocations drive performance. Objectively, it is satisfying when investment choices meet and/or exceed their numerical benchmarks. Not so much when they don’t. Subjectively, because it validates our efforts to educate clients on the benefits of diversification, it is often more gratifying to hear them express an understanding that a diversified portfolio’s overall performance will rarely mirror that of a major equity market index like the DJIA or S&P 500. This, despite what are strong and very real behavioral tendencies to the contrary. This is where VUCA and discipline around allocation converge. VUCA will always exist, so investors should be disciplined and not fall prey to the greed of seeking higher returns or, becoming too fearful when markets appear unsustainable or suffer substantial drops.
Because US equity markets had appreciated significantly after the November elections, the decision was made to trim selected positions at the end of 2016 and again in early January to spread gains over 2 tax years. These included our banking positions as well as some large-cap and mid-cap investments, all of which had seen nice gains. For the most part, proceeds were left in cash in anticipation of the usual 1st quarter IRA distributions and tax related transactions. Like most years, as January comes to a close, we have more clarity around client cash needs and what might remain for reinvesting. Unlike most years however, some US equities have seen more short term appreciation in last several weeks. This appreciation and rapid rise to 20000 prompted debate about the merits of additional trimming and whether to reinvest or increase cash. Fortunately, when US equity allocations increase there is an opposite and equal drop in other areas of a portfolio. This makes the decision of whether to reinvest cash and how much a little easier, particularly when variances call for the proceeds of equity sales to be invested in the safety of bonds.
In the coming weeks, we will embark on an even more critical assessment of earnings and the economic landscape than we might otherwise conduct given the current political VUCA we are experiencing in the US. We will continue to invest in those areas we believe hold value and/or act as buffers against market declines like bonds. Rapid market appreciation may result in the accumulation of cash over the 1-2% usually seen and will also prompt an even higher level of prudence when increasing equity exposure. As my Rector did last Sunday by encouraging each of us to find ways to make positive, individual contributions, we will strive to maintain a make sense out of the geopolitical and investment VUCA while providing personal attention to client portfolios as directed by their allocation strategies and individual tolerance for risk.