“Kee” Points with Jim Kee, Ph.D.

  • Politics and Stocks
  • Themes: Go Small?
  • Volatility


Politics and Stocks

I know that the headlines have been focused on the return of market volatility lately, but the most interesting thing I saw last week was a Wall Street Journal article on ethical investing. The article looked at the relationship between politics and mutual funds/ETFs (exchange traded funds) that invest with a Social, Governance, or Environmental purpose, known as “ESGs.” Fund flows into ESGs grew throughout the Bush presidency and then flat-lined (pretty strikingly) during a lot of the Obama Presidency before increasing again, under President Trump. The assertion was that money flows into these funds when it looks like the government is going to be lax on ESG issues, and it flows out of them when it looks like the government is going to be ESG-vigilant. For a rather striking example, in the month after the 2015 Paris Climate Agreement, $50.1 million flowed out of environmental-focused funds. In contrast, $98.8 million flowed into these funds when President Trump withdrew the US from the agreement in 2017. The implication is that investors use ESG investing to express their political preferences, or to counter thwarted preferences. The real acceleration of funds into ESG occurred from 2012 onward, and while the authors didn’t make this case, I would tie that to the rise of the tea-party and the Republican takeover of the house that occurred in 2012. The implication is that ESG investors perceive Republicans to be soft on ESG issues.


Themes: Go Small?

To test this, I thought, what would be the Obama-era version or analog of this? That is, what investment vehicles did non-Obama voters pursue? If you followed the press and the internet during that era you know the answer was, “buy gold.” To quote The Economist magazine back in 2011, “The demand for gold depends on airier considerations, such as whether you think Barack Obama is the Anti-Christ.” That’s exactly what we saw. Looking at gold prices, the price of gold actually fell going into the Great Recession but bottomed around the 2008 Presidential election. It then rose straight up, from around $720 per ounce that fall to a peak of over $1800 by….2012. After 2012 it declined to as low as $1050 by 2016, and currently trades at around $1328.5 (04/09/2018). Gold and ESG investments of course have multiple drivers, but the political story here fits the data pretty well.


And that’s what a lot of “thematic investing” really is, i.e., story-telling. That doesn’t mean it’s wrong (or right), but putting ideas into a compelling narrative is how business writers and strategists make a living. I saw a great example of this recently in a Financial Times article, “Forget big, investors should go small.” The author pointed out that big countries are at most risk from a trade war (so focus on smaller ones), big companies are most subject to regulatory/antitrust actions (so go small), and regional opportunities are better than global ones. Included in the argument was the usual ‘small-better-than-large’ assertions of more growth potential and lower debt levels with smaller companies. Countering this view is the narrative from some (e.g. Jefferies) arguing not to go small because small companies are dependent upon, that is, they sell and service to, larger companies. That makes sense too! In fact, I tested this as a strategist over a decade ago, trying to differentiate between small companies that thrive when large companies thrive (a complimentary relationship), versus small companies that compete head-to-head with large companies (an adversarial relationship). We (my team) also differentiated between small companies that were “emerging” or growing fast (the typical perception), versus small companies that were really just beaten-down former large companies (i.e. their market capitalization had fallen dramatically). There were pages and pages of great stories that this “matrix” between small and large company stocks could yield, and yet the practical investment insights (after back-testing numerous implications) were basically zero. My conclusion, one consistent with about 50 years of peer-reviewed research, was just to always own both small and large company stocks, and that’s what we do here at STMM. I make this research digression to make the point that real long-term investing success rests more on investment discipline and company-specific research than it does on compelling stories or themes.


Volatility

Back to the markets and the return of volatility, I think Jack Bogle’s advice is helpful. Bogle describes the increased daily volatility and trading with a quote from Shakespeare, “a tale told by an idiot, full of sound and fury, signifying nothing.” Of interest to speculators, says Bogle, but not to long-term investors. Great advice from Bogle.