Albert Einstein said, “The intuitive mind is a sacred gift, and the rational mind is a faithful servant. We have created a society that honors the servant and has forgotten the gift.” The very same logic can be applied to developments in financial markets and the way most of us have accepted the recent abundance of positive returns in equities as being rational, especially since Donald Trump was elected to office. Those very rational, faithful, servant minds are the ones allowing for a new focus “within”—turning away from global affairs, and anticipating improvement upon the economic malaise of subpar returns and real employment through the rejuvenation of domestic manufacturing and infrastructure spending.
The gifted, intuitive mind—the one reminding us of all being “too good to be true”—has been commonly “left in the dust” for quite some time. Admittedly, it is hard to apply common sense to current affairs, as there are some logical trip-ups, if not fallacies, to be considered:
- The Financial and Real Economy Are Not Interlinked. As much as critical market observers want to point to the fact that prices in equity markets are not reflective of real economic conditions (mainly GDP growth), and that, for this very reason, returns will have to adjust (come down), research shows it is a regular occurrence that economic growth does not correlate to either earnings or price returns of listed companies; this phenomenon holds true globally and has been researched (samples can be found here and here).
- Valuations Do Matter. There is a simple formula to investment success in the long-run, at least in my mind: cheaper is better, value beats growth, small (cap) is better than large. Applying this logic to current affairs, investors have to accept that they are “in” for mostly lower returns based on valuations in U.S. markets; this is a critical distinction to make (as it is currently almost distasteful to look for investment opportunities beyond U.S borders) in spite of many markets having become very attractive from a valuation perspective.
- Accommodative Policies Have Changed Everything. One thing that has changed in pursuit of rational explanations is utilizing well-researched historical market outcomes to draw conclusions about the direction of markets, including future return expectations. With many traditional indicators “screaming” danger (see example here) given current price and valuation levels, accommodative policies—monetary and (now) fiscal—are trumping (no pun intended) rational-minded outcomes; one clear indication is the perceived absence of risk, as measured by near-record-low levels of the volatility index, the VIX.
In closing, and to make the matter even more complex, we better trust that the assumptions placed around the effectiveness of accommodative polices will remain true; otherwise, our intuitive and rational minds will face a reality where future returns were unsuccessfully pulled forward, with the real and financial economies not coming through. Should this collective mindset ever take hold, the ramifications in financial markets will be sobering at best. With this in mind, seek value, diversify globally, and have a financial plan to pursue personal goals, not index returns.
P.S. To reveal the true difficulty in assessing all that may matter, and our need to stay inquisitive, especially when investing our money, there is a refreshing debate going on regarding whether or not Einstein was, in fact, ever linked to our introductory quote…
Matthias Paul Kuhlmey is a partner and head of Global Investment Solutions (GIS) at HighTower Advisors. He serves as wealth manager to high-net-worth and ultra-high-net-worth individuals, family offices and institutions.