This winter we are excited to introduce you to our winter intern, Armani J. Nieves. Armani is a freshman at Bryant University and is majoring in finance. He first became interested in the world of finance in middle school when he started purchasing stocks. Armani envisions himself working with people to support them in achieving their financial goals when he receives his undergraduate degree.

The following post is written by Armani Nieves:

Inflation, poverty, starvation are words that are synonymous with the economic situation in Venezuela. In addition, investment, growth, diversification are words that are almost synonymous with the economic situation in Saudi Arabia. How can two countries, in a world of overall growth and prosperity, vary so much? It all stems from asset diversification.

In 1970, the price of oil skyrocketed and increased to $120 a barrel. As a result, this caused Venezuela to become the richest country in Latin America. Venezuelans lived lavish lifestyles and enjoyed earning high wages. However, when oil decreased in in the 1980s, inflation rose 80% in this country.  The temporary adjustment to this problem was to cut government spending as well as open financial markets. Although this supported an increase of GDP from -8.2% to 4.4%, employee wages continued to remain low while unemployment remained high. This was only a warning of the dangers when countries predominantly invested in oil.

In the summer of 2014, a strong US dollar and higher output of oil resulted in the price of oil decreasing. Now, Venezuela experiences inflation like never before. In 2016, Venezuela experienced a 2,000% inflation. Although the price of oil is steadily rising, it will take a long time for Venezuela to recover as a result.

On the other hand, Saudi Arabia has undergone a massive initiative to get its country’s economy not to rely on oil. Saudi Arabia started this initiative after observing how dependency on oil may negatively impact a country’s economy. Saudi Arabia is diversifying its investments from oil to real estate, technology, and startup companies. Furthermore, they have been developing new solar farms. Research labs have been created in the King Abdulaziz city of Sciences and Technology to study and improve solar technology. They have invested over $50 billion into producing wind and solar projects by the year 2023. Saudi Arabia is pushing to become a global player in the renewable energy market.

From examples provided with both Venezuela and Saudi Arabia, we learn the lesson of not “putting all our eggs in one basket”. Venezuela put predominantly their “eggs in one basket” cited for oil. However, when oil lost its value, this country lost a lot of its financial resources. On the other hand, Saudi Arabia placed their “eggs in various baskets.”  So, when oil prices lower again in the future, Saudi Arabia will be ready and may continue to profit in other manners. As a result, it is important that we do not put all of our financial resources into one stock. For example, if we place all our financial resources into the technology or healthcare sector we could be taking on a significant risk. If healthcare were to have a bad year, your portfolio could be negatively impacted. It is always important to invest in different sectors. The example of Venezuela and Saudi Arabia can serve as a good reminder of the importance of diversification – not just at the individual level, but at all levels of investment (including government investments).

In our previous post, we explored the high-level art versus science debate that is occurring in the finance community and how it impacts equity valuations.  This post delves into some of the issues as they relate to bonds and fixed income.

Although the bond markets are multiple times larger than the stock markets, they receive far less attention. These markets are usually set by free market forces. However, today it is no secret that Central Banks are manipulating interest rates in an effort to artificially stimulate demand for loans in an effort to provoke greater economic activity. Consequently, interest rates are at 100-year lows. These Central Banks need to hold interest rates down to avoid paying higher rate payments on the ever-increasing mountain of government debt. Currently, this debt is currently over 100% of the entire nation’s GDP (If interest rates were to rise, interest payments on the debt alone could consume the entire amount of taxes that are paid).

The plan of the Central Banks around the world is to create new money, buy bonds, and keep interest rates low until the economy revives (Quantitative Easing). Inflation will then pick up along with higher wages. Deficits will subside due to higher taxes from a growing economy. Total debt will shrink relative to a larger economy and interest rates could slowly rise to free-market levels. Again, politics influences economics and politics cannot be reduced to computer models.

For the average investor, duration and must be considered. Duration is a very important concept for bondholders. It measures the degree of risk of principal loss should interest rates rise from our current historic very low levels. For example, if interest rates rose by 1%, an investment-grade bond with an SEC yield of about 2.4% and duration of about 6 years could lose about 6% of its market value.  Given the meager 2.4% SEC yield that is not much reward for that much risk. Currently, government policies are holding interest rates at depressed levels. Should interest rates rise, many investors would be left with unexpected losses.

Given the potential explosion of future events, a human element is needed. It has become increasingly obvious that some things are not reducible to mathematical equations. Investment planning is an art that requires a human touch not just mathematical science.

In our previous post, we explored the high-level art versus science debate that is occurring in the finance community.  This post delves into some of the issues as they relate to equities.

The Science Argument: Valuation. There is a camp of investment managers who believe that the value of a stock is simply the present value of future earnings. After all, it is no more than partial ownership of a business. Viewed as an investment, the long-term stream of future cash flow must justify the initial cost of the investment. Therefore, stocks have a fair value based on past, current, and estimated future earnings. Historically, there has been a fair value for the major stock indexes which is in the area of 15x’s earnings. Higher than 15x’s earning, the stock market is expensive; lower than that, the market is cheap. Currently, the major indexes are over 20x’s earnings.

The law of fair valuation states that, while actual prices will fluctuate, fair value will inevitably win over the long-term. But in the short term which can last many years, perhaps even a decade, this law is at best obscure. This brings into play the second, and often the more important rule.

The Art Argument: The Trend is your friend.  As mentioned, in the short term, value may not be the best indicator. Instead, we in believe momentum and mass psychology rules. It is currently ruling up. Once a direction is established, either up or down, it takes on a life of its own. Numerous factors have combined to yield 10 years of low volatility. Stock market sell-offs have been minor despite subpar economic growth and high valuations. Many argue that an important factor is that central banks around the world have been openly buying assets (bonds & stocks) to boost prices and to induce economic growth. This intervention induces another factor of stock buy-backs on the part of our major corporations to boost earnings per share; this has created enormous upside momentum. Furthermore, it is common knowledge that the Federal Reserve will support asset prices when necessary (the Bernanke Put).

As a result of these influencing factors risk awareness has been dulled and, in the short term may be rightfully so. The stocks markets continue to smoothly chart higher and higher. But is the concept of fair value still lurking out there?   When, if ever, will it return?  But in the meantime, there may be a great deal of money to be made. And, after all, many, many good things are happening that could rightfully drive the markets by increasing earnings and thus fair value.

Further complicating proper investment decisions is ever-changing government policy. For example, our government is now in a heated debate over tax policy. If they lower corporate tax rates, what will that do to boost earnings? If the abundance of cash reserves held overseas by corporations are induced to come home, what will that do to stock buy-back programs and economic expansion? Politics influences economics and politics cannot be reduced to computer models.

So can investment planning be reduced to math inside of a computer model? We would argue that a human element is needed. It has become increasingly obvious to us that some things are simply incomprehensible and that investment planning is just as much art, as it is science. This is especially true in today’s world where headlines are manipulated and central banks of governments are overriding free market forces.

This post kicks off a series that delves into an important debate unfolding in the finance community – is there an art to investing or is there a science to investing?  Often times, this leads to a lot of other debates such as the active versus passive investment debate.  It should come as no surprise, that we believe in both.  There is a role for art in investing and that it works in tandem with the science of investing.

What makes this series especially interesting for me is that I am joined by my colleague, Cliff Jarvis.  He has been a financial advisor with Ohanesian / Lecours for over twenty years and brings a wealth of strategic insights and perspectives that round out our investment committee.   So let’s delve into it with Cliff providing an overview of the art versus science debate:

Many years ago economists developed mathematical models to optimize investing. Sounds simple. But is it really in a world of changing rules, unexpected events, and evolving individual needs? The following series explores why investing is more than math and why a constantly changing macro-environment and evolving personal circumstances demand a human touch that is set apart from mechanical empiricism. Our belief is that investing is an art not just a mathematical science. The following series starts with the world as it currently is and, hopefully before the series ends, will enhance the investor’s ability to successfully cope with investing.