What goes around, comes around.

Boybands have been around forever in music, with some saying The Beatles were one of the first. I can easily list a boy band for each of the decades I have been alive. In the 70s the Jackson Five had us “blaming it on the boogie”. New Kids on the Block were just “hanging tough” through the 80s. In the 90s the Backstreet Boys encouraged us to “get down (and move it all around)”. One Direction reminded us to “live while we’re young” in the 00s. Today “life is dynamite” with BTS – the Korean Pop group taking over the world. These boybands seem to explode out of nowhere, with earworms and anthems that are inescapable, minting money through mass-marketing and promotion, growing hordes of “die-for-you” fans – and then unable to stop the march of time, the “boys” grow up … and inevitably it is time to start looking at solo careers!

Justin Timberlake has worked tirelessly to anoint himself the “Prince of Pop”, desperate to be the successor to the throne of Pop music. After outgrowing N’Sync, he hit the airwaves with an impressive number of singles, most of which gained traction on the heels of his breakup with Britney Spears (indisputably the “Princess of Pop” in her prime). Working through some personal trauma, one of his first big solo hits “Cry Me a River” features a Britney lookalike, who he discovers has been cheating on him. Infidelity is explored again in his song “What Goes Around…Comes Around”, where he uses a popular expression to preach that if one treats others badly, they should be prepared to be treated badly by others in the future. Parents also used this simple expression to encourage their children to “be good”. This expression has grown out of the Hindu concept of “karma”, whereby all our actions, both positive and negative, will put out positive or negative energy into the world, which will be returned to us in some form. This principle is meant to guide us towards being the best we can be so that we can benefit from receiving positive energy in its many forms. If Timberlake can use karma to describe his romantic relationships, let’s explore how “what goes around, comes around” can be extrapolated to financial markets.

Mean Reversion is a theory used in finance whereby valuation multiples and volatility eventually revert to the long-run mean or long-term average levels. This implies that when markets go up or down, they will come back around (to the long-run mean). In decision-making, mean reversion can be used as an indicator or signal to buy low or sell high, when observing an asset is priced outside of the normal distribution of valuations or expected return. The return to a normal pattern is not guaranteed, as paradigms can shift the norms. Examples of normal distributions of outcomes and their stabilities (whether or not a paradigm shift is likely) differ across data sets. As sports fans will know, the performance of an athlete is relatively stable over their career until the toll of training, competition, and age (not unlike their boyband counterparts) catch up to the individual and performance begins to deteriorate. This is when we will see a paradigm shift occur. General managers, scouts, and player personnel of sports teams live and breathe this framework daily, trying to identify who is having an off-year and who is more (or less likely) to revert to their mean of expected performance. To counter, they try to trade players who are playing above their “weight” for players who are expected to mean revert. Championship teams are built on the shoulders of scouts who can distinguish between gems and rocks, with a degree of consistency. Asset management firms work just as tirelessly to find undervalued gems to invest.

On the Subject of Gems & Rocks

A few months back I wrote about experiencing my first hockey draft since moving home from the Middle East, “The Rick-Toe-Shay Classic”. For the first time in my years of participating in sports drafts, I decided to try something different and placed my trust in “the experts” to create my team. Two weeks into the season, I found myself in first place, but not optimistic that it would last, as I had some early outliers. Two weeks later, sure enough, my team was dead last.

Was I panicking or despondent in that position?

Had the experts let me down?

I took the time to review my team and noticed my number one pick, Mikko Rantanen, was well below the average for the round. Rantanen was a full 19 points behind Connor McDavid. I consulted with our league expert whose initial analysis of my team on draft day had rated it as solid (other than my number one pick). He brought up that Rantanen is not considered a star player, but rather a supporting player—in the sense he needs to play with stars to get his points. His star was Nathan Mackinnon, who had been out for the past two weeks. This information provided some insight into why Rantanen had dropped off in scoring. Fast forward to today, my team is now in second place with my players on a mean-reverting tear for the past five weeks. Rantanen is now two points above the round average. So, what is holding my team back from first place? The team in first place has the same number of below-average players but where they have three star players leading their rounds, my team has none. As the adage goes, you don’t win without your star player performing and over-achievers in supporting roles.

“The Markets Can Remain Irrational Longer Than You Can Remain Solvent”

Fine words from one of the founding fathers of financial investing, John Maynard Keynes, to explain times when the perception of value may differ from long-term intrinsic value. After losing all his wealth in the market in a month, Keynes noted that markets can act perversely in the short term. Using this experience, and with seed money from an anonymous financier, he began re-investing, but with more caution and flexibility. This experience helped him to invest strategically to outperform the stock market by eight percentage points a year, over a twenty-year period spanning the Great Depression. He was able to recoup his losses, and then some! Warren Buffet’s quote “Only when the tide goes out do you discover who’s been swimming naked” references the capacity for market valuations to move away from the long-term mean. At WealthCo, we want to ensure that you always have your suit on!

The chart above highlights the change in the long-term trend line in the S&P 500. This coincided with the market bottom in March 2009 which led to 11 years of relatively uninterrupted economic growth and a steady decline in interest rates. The Covid-19 pandemic-induced recession of 2020 had a short-term effect on equity markets with valuations now above pre-pandemic levels. WealthCo continues to be concerned with the ability of large-cap US stocks to stay above the long-term trendline. The opening up of the economy is expected to result in GDP growth of 5.5% in 2021, which would be the fastest pace since 1984. However, for valuations to be justified, the US would need to continue growing above the recent trend of GDP growth. We do not see a catalyst that would drive a paradigm shift in long-term economic growth to the upside for valuations to remain supported.

WealthCo continues to invest in the equity markets at our target allocations or ~35%, for the long run. Over the short run, we will continue to leverage our winners and seek opportunities that generate returns through diversified economic exposure. This enables the portfolio to be diversified in multiple sectors of the economy across the globe. We expect to seek investments in assets such as the following:

  • Private credit provides current income by lending to borrowers that are improving their creditworthiness by increasing the cash flows of their collateral. Unlike governments that may have deteriorating balance sheets.

  • Private investments in companies, real estate, and infrastructure assets are growing cash flows at a faster pace than GDP. These assets can be managed strategically over a three to five-year holding period to grow revenue, improve margins, and reinvest in the business. WealthCo believes that long-term business building is simpler in a private ownership context with strong alignment between key stakeholders.

Hello Experience, My Old Friend

Unlike singers in a boyband and professional athletes, time and experience can be great assets to an investor. The ability to learn from experience, good or bad, enables WealthCo to continually enhance our investment processes to build institutional quality portfolios. Our objective is to compound our client capital with lower volatility. To borrow from the words of Justin Timberlake (and adapt them for our financial purposes):

“Is this the way it's really going down?

Is this how we say goodbye?

Should have known better when valuations were too high

That you were gonna make me cry…”

Unlike relationships, financial markets can leave you more than heartbroken.

WealthCo is here to help you stay the course and invest with your head, and not your heart.

In the words of the legendary Bruce Springsteen, “Hey there baby, I could use a little help” – share this article with your family and friends who might be overly exposed to equity and bond markets during these emotional times.

WealthCo Asset Management offers no-obligation portfolio reviews to investors who are wondering if their portfolio is in line with their objectives and risk tolerance.