One week / one topic: Renting vs Owning

What happened?

Apparently, Goldilocks macro conditions are back given better retail sales, softer Producer Price Index (PPI) and lower import prices.

And yet, we increasingly live in a world where investors are much more inclined to rent assets rather than owning them, as quick gains become more and more addictive.

In his landmark experiments on pigeons, B.F. Skinner developed three key insights: immediate rewards work better than delayed ones, unpredictable rewards work better than fixed, and conditioned rewards work better than primary.

In particular, conditioned rewards are things we learn to desire – as opposed to primary ones, which are mostly linked to our biological needs.

Humans, it turns out, are fairly similar to pigeons (I know) when it comes to this… and therefore very susceptible to the immediate, unpredictable rewards that markets regularly offer in the form of quick gains.

Traditionally, investors have always looked for ‘intellectual anchoring’ to guide their actions as they attempt to avoid chasing prices at the risk of getting whipsawed. (which is an even more valid concern in the age of Tariff Man)

If you believed in those guiding principles, then you were more inclined to own assets which you believed were trading below their intrinsic, fundamental value.

Alas, guideposts like valuations are very difficult to define with clarity, and they only tend to work at the extremes – i.e. outside the (ever larger?) ‘zone of indifference’.

Even US Treasuries – long considered the bedrock of the global financial system – are not what they used to be, in the eye of many investors.

Historically, there used to be some anchoring between underlying GDP growth and long-term rates – despite the inevitable temporary divergences, and ensuing debates about the logical foundations of this relationship.

Now, it’s seemingly all gone…

Perhaps understandably then, investors are even more likely than usual to be conditioned by the immense power of immediate, conditioned rewards given that old ‘rules of thumb’ have been crumbling one by one…? (Hint: yes)

Welcome to the era of ‘Airbnb investing’ then, where all that matters is the short-term experience.

Who is the landlord? Well – the government, of course… craving votes at the ballot box instead of 5-star reviews.

The incentive is clear: people tend to vote you out of power, if they became poorer on your watch!

Our observations

• Fundamentals: Markets are (almost always) not stupid. The emergence of ever larger cohorts of price setters in the form of retail investors and hedge fund pod shops is not a coincidence, it’s a reaction to the underlying conditions. Accept it.

• Price action: ‘Buy the dip’ has worked for equities pretty much since the Global Financial Crisis… how could this have not conditioned investor behavior?

• Investor beliefs: When things go wrong, we have become used to the government stepping in with ever more stimulus to bail us all out. Bitcoin and Gold have noticed!

So what?

Like in most other endeavors, investors don’t get to choose the cards they are dealt.

There are many reasons for our predicament: the rise of price-insensitive passive investing, attention spans getting shorter and shorter, a pervasive feeling of entitlement, a general sense that things are not what they used to be (well beyond what pertains to financial markets), and many more of course.

That said – and as uncomfortable as it may be, in the face of runaway prices – it is our fiduciary duty (!) to keep paying attention to the lessons of history (periodically, things go wrong and investors lose their minds) and the power of diversification.

This is not at all to say that we are bearish at the moment – and in fact, our equities positioning is at fairly constructive levels – but it does speak to the relatively low level of confidence attached to it.

As we find it easier to define what we don’t want to own in portfolios rather than the opposite then, we are targeting specific themes (Global AI opportunities, Japanese banks, Japanese small caps, Emerging Markets value) while retaining a strong focus on diversification.

Mood music: Edward Sharpe & The Magnetic Zeros – Home