2017 has brought immense uncertainty. It's important to position your portfolio accordingly.

We recently received the following question from one of our shareholders. If you have questions you'd like to ask our team, please email us at [email protected].

Despite the belief in and commitment to being long-term holders of investments, there have been disconcerting articles making the case for a dourer fundamental outlook for the future of our economy for the upcoming generation(s) by  David Brooks and Mohamed El-Erian.

Have you a personal assessment of their outlook and how might it affect your investment strategy?

Thank you for a considered reply when you get a moment. -- Ned, Shareholder, Independence Fund


This is a complex question, and I hope I can do it justice.

My first reaction to reading your linked articles (I haven’t yet read El-Arian’s book, so I can only go by the take of the article’s author) is to be reminded how short human memory can be, particularly in stock markets.

I think one of the most significant results of this “Age of Central Banks” is that we’ve all forgotten there are natural cycles in business, culture, and politics.

Boom follows bust follows boom.

Fashion gets recycled every 20-30 years, so my grunge-era wardrobe should be back in style any time now. (Here’s an article with one man’s theory as to why this happens.)

Republicans and Democrats swap the Oval Office every eight years or so.

Pendulums swing from side to side, and the middle is very rarely the current state.

Neil Howe and William Strauss put out a book in 1997 called The Fourth Turning, which lays out the theory that we exist on a generational wheel. (Howe recently wrote a piece in The Washington Post summarizing his book that’s worth a read.) The idea is that each subsequent generation is shaped by the prior one, so that over the course of 80 to 100 years, we run through four stages of cultural shifts.

For example, do you know what was happening about 85 years ago? Herbert Hoover’s administration was responding to the Great Depression by “suggesting” that Mexican immigrants (and some Americans of Mexican descent) shouldn’t be in America anymore.

We’ve been here before, and we’ll probably be here again. Humans are social beasts, but when resources are scarce, our social circles tighten and we revert to our tribal selves. Slow economic growth reduces available resources. Our base natures come through.

But droughts don’t last forever. Economic malaise ends. This, too, shall pass.

Looking for Islands of Positivity

However, bad times can last far longer than anyone would like them to. Just as the saying goes that markets can remain irrational longer than you can stay solvent, there’s pretty strong evidence that droughts brought about the end of some major ancient civilizations.

So it would be far too glib of me to brush off the gloomy outlooks you highlight. However, even in the dour economic world Brooks and El-Arian describe, there is probably going to be some growth. It may not be widespread, but there are likely to be islands of positivity. Even the author of the El-Arian article highlights biotech, the sharing economy, the industrial internet, and energy as places seeing positive developments.

As your investment team, it is our job to find those islands of positivity.

In the Age of Central Banks, stock picking has been a tough row to hoe, because whole markets have generally gone up without pause (with the strong exception of the energy sector in 2014-2015). In this world, indexes are able to deliver strong returns by just holding a broad sample of stocks.

This environment has led to a boom in index-tracking ETFs and mutual funds and a steady outflow of money from actively managed funds. And that makes sense. Why pay someone extra money if you can get the same or better results for cheaper?

Here's why

If we are indeed in for a more tumultuous world, we think active managers may rise again. In a more volatile world, there is likely to be a benefit to finding the best-run, most innovative companies and putting your money in them, rather than in the whole index.

Well-run companies that make things people need, or things they think they need, will still be able to generate decent returns for shareholders. Those that help people or other companies do things more efficiently or more cheaply will probably also do well.

In a slower-growth, more volatile world, I think that there will probably be a clear separation between great and average companies. Companies with sharp capital allocators, good growth strategies, strong innovation, and a complete focus on customer satisfaction should be able to rise above the fray.

So these are the companies we’d look to own in the type of world that Brooks and El-Arian describe.

It just so happens that these are the kinds of companies we’ve always tried to own, so we’re pretty well situated on that front.

That doesn’t mean we won’t see our investments hit by a broad market sell-off, but if we’ve done our job, the fundamentals of our companies should be strong enough to survive a world with more downs sprinkled among the ups.

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