As someone who grew up in the New York area I’ve savoured the Knicks season which ultimately ended with a championship on Sunday.
Over the past several weeks the Knicks have brought a good deal of joy to my life.
I’ve reconnected with mates from high school who I don’t talk to often enough.
I’ve experienced the gambit of emotions that comes from watching a series of closely fought games.
I even hugged a random man in the Sportsmen Bar in Bangkok at 10am after the Knicks epic game four comeback.
Reflecting on the Knicks’ run I’ve come up with three lessons for investors. Is this a stretch? Perhaps. But indulge me this one last editor’s note.
Be wary of the shiny objects
The NBA finals was a David vs Goliath match-up.
Playing the role of Goliath was Victor Wembanyama of the San Antonio Spurs – Wemby for short.
He is everything you want in a basketball player. His physical gifts are obvious given his height and his ability to do things that somebody with his size shouldn’t be able to do.
Despite only being 22 years old, Wemby has already been anointed as the new face of the NBA. Wemby carefully crafted his image which has worked surprisingly well in a cynical age.
Wemby was widely praised for training with Shaolin monks in China to improve his balance. He was declared an intellectual because he reads and plays chess. The media deemed him a deep thinker when he sat in the park sketching some tree. To me this all seemed a tad performative...but everyone swooned anyway.
The mantle of Goliath’s diminutive foe was taken by Jalen Brunson.
On paper Jalen is everything you don’t want in a basketball player. He is slow and short – at least for the NBA. When he joined the Knicks the commentators universally criticized the move as Brunson was “not a saviour in any way, shape or form.”
Nobody gave David or Brunson a chance.
Yet David confidently told Goliath before battle, "This day the Lord will deliver you into my hands..."
And when faced with his own giant, Brunson told the world he wouldn't be backing down either, “Some guys are always gifted: Amazing length, amazing athleticism. But just put me in front of that guy. That's my mindset. I'm gonna battle.”
It is human nature to reflexively find some things more compelling than others. In the NBA a 7-foot, 4-inch player with a compelling – if slightly nauseating – narrative is always going to be more intriguing than a 6-foot player who is reserved and rarely speaks.
Investors are naturally drawn to certain things and this can have consequences as high valuations often lead to lower returns. Jeremy Grantham summed it up well in his book The Making of Permabear (I read books just like Wemby!) saying,
“Historically, equity investors have overpaid for excitement and sex-appeal: growth, profitability, management skills, technological change and, most of all, acceleration in the above.”
Savy investors understand this tendency and view markets in a more nuanced and holistic manner. There is plenty of data to back up the benefits of this approach.
Professor Robert Haugen dedicated his academic career to showing that boring shares – those with low volatility – did better over the long-term than the exciting shares investors are drawn to.
In his 2012 paper titled Low Risk Stocks Outperform within All Observable Markets of the World he showed that in 21 developed and 12 emerging markets the shares in the lowest decile of volatility outperformed the highest volatility decile in almost every instance. Read more on his work here.
Professor Jeremy Siegel explored returns across the 20th century and discovered the best performing US share was cigarette company Philip Morris. Why? High dividends reinvested at reasonable valuations.
During a century of innovation none of the companies that invented or commercialized the airplane, medical breakthroughs, the computer or the internet led the list – it wasn’t the shiny things that led to the best investor outcomes.
It is easy to be seduced by potential. But a good outcome requires more than the glimmer of promise. It means paying a reasonable price for growth and finding companies with moats to minimise the impact of ruinous competition. These intangibles get lost in the hype over the next great investment.
There was never any hype over Jalen Brunson. Yet he won a state championship in high school and a national championship in university. Now the NBA. He has the intangibles that aren’t readily apparent to everyone.
For Wemby talent alone wasn’t enough as he missed key shots and turned the ball over at the end of the game. He needs more seasoning, maturity and experience – and maybe this will make him into the champion he was prematurely declared.
Don’t lose sight of the definition of success
In a bizarre and childish press conference after the final game Wemby talked about how the Spurs dominated a series where they won one out of five games.
Most of the games followed a familiar pattern. The Spurs would build a big lead and ‘dominate’ the first quarter. Then the Knicks would come back to win as the Spurs made mistakes and a visibly fatigued Wemby became a bystander.
All that matters in basketball and investing is the end result. As Nassim Taleb said “It doesn’t matter how frequently you succeed if failure takes it all away.”
Like Wemby, investors often can’t see the forest for the trees. Executing a plan to achieve a long-term goal is far less exciting than finding the next 10-bagger. Most investors focus on the latter and forget about the former.
The key drivers of success – asset allocation, minimizing taxes and fees, risk management – are ignored in the quest to ‘dominate’ with the highest returns possible. This pursuit often causes investors to sabotage their long-term returns.
Remember your strategy when things seem too easy
In the beginning of game four the Spurs couldn’t miss while building a 29-point lead. I handled this disturbing turn of events with my customary grace by rapidly consuming Changs.
In the second half the Spurs started to miss a few shots and the Knicks inched closer. There were several things the Spurs could have done - take more time off the clock or perhaps throw the ball inside to the guy the Shaolin Monks had to push three cots together to accommodate.
The Spurs did none of those things. Instead, they shot eight straight three pointers as quickly as they could each time they had the ball. This series of poor tactical decisions contributed to the Knicks’ eventual comeback.
When times are good it is easy to deviate from a plan. The Spurs didn’t’ think they needed to stick to a strategy when all their shots were going in. Investors don’t think they need a strategy when everything goes up.
Standards and discipline get thrown out the window in bull markets. If you are a value investor and the SpaceX IPO is starting to look good it might be a sign you are falling into this trap.
This hubris will catch-up with investors in the next bear market. To paraphrase Hemmingway, this reckoning will occur gradually… and then suddenly .
A strategy doesn’t have to be complicated and Buffett came up with one almost anyone can use:
“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.”
Final thoughts
As the buzzer sounded in the last game Wemby stormed off the court without bothering to shake the hands of his opponents. He ended his press conference by telling the assembled reporters, ‘see y’all, never’.
But the first Frenchman to ever say ‘y’all’ will be back – likely with an entertaining story about an obscure training regime.
Perhaps it will be the Bushmen of the Kalahari or a sherpa in the foothills of the Himalayas that will help Wemby to – literally and figuratively – elbow his way to his first championship at all levels of basketball.
Jalen Brunson will be in the gym. He will be practicing the hypnotic array of crossovers and head fakes that allow him to weave through tree trunks of men for a critical crunch time layup.
Investors will continue be tempted by the next can’t miss investment by proselytizing charlatans in well-appointed suits.
Resist the siren song of get rich schemes and instead focus on the un-sexy work of building wealth to create a better life for yourself and those you love. Leave the hype and flash to others and create a life worth living.
Mark LaMonica
Also in this week's edition...
The ASX's largest stocks are leaving much of the market behind. Tim Carleton from Auscap shares his thoughts on why high quality businesses are on sale.
Owen A. Lamont from Acadian examines something new and unusual in markets: high value-weighed dispersion.
Wealth concentration is at an all time high. Michael Collins looks at why inequality may be a broader threat to economic stability.
AI hype is sweeping global markets, however, Roger Montgomery thinks its four horsemen could bring a reckoning.
Jason Nassios and Beth Webster share why the budget tax reforms barely scratch the surface and explore what Australia needs next.
Trevor Schmid discusses why negative gearing did not die on Budget night.
Hayden Green explores how family offices have quietly taken over Australia's private capital.
This week's white paper from GSFM affiliate, Man Group, looks at the growing divide AI is creating across the technology sector.
Curated by Simonelle Mody and Leisa Bell
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Weekend market update
From Shane Oliver, AMP
The past week saw good news with the US and Iran at last signing (at least electronically) a peace deal that will reopen the Strait of Hormuz. While a deal had already been anticipated its confirmation and reports that sanctions on Iranian oil would be lifted saw oil prices fall further taking them to less than $US10 a barrel above where they were before the War started at the end of February.
The deal provided a boost for global share markets with US shares up 0.9% for the week albeit with a more hawkish Fed limiting the gains, Eurozone and Japanese shares reaching new record highs and Chinese shares also up. Australian shares were helped by the positive global lead but only rose around 0.1% for the week not helped by a fall in BHP after it announced a project cost blow out. Gains on the ASX were led by health, finance and retail shares but these were largely offset by falls in energy, utility and telco shares. Australian shares remain relative underperformers so far this year as RBA rate hikes, worries about the impact of the Iran war and Budget tax changes have impacted.
Bond yields fell in the last week helped by the further fall in oil prices. Iron ore prices were flat but copper and gold prices fell as did Bitcoin and the $A, as the $US rose on the back of a more hawkish Fed.
The backdown on Iran coming on top of the US backdown in its trade war with China – highlights perceptions that its in relative decline and lacks the stomach to follow through to complete victory. Which in turn is consistent with increasing geopolitical instability as the US is in retreat as the world’s cop. But of course, that’s a separate issue!
Back to oil prices – in the short term further declines may be limited as a deal was largely already priced in and it will take a while for Middle East energy production and flows through the Strait to return to normal and markets are likely to price in a risk premium to allow for the risk it could all flare up again. So global central banks are likely to be wary of relaxing too much regarding the threat to inflation. However, past oil price shocks have eventually been followed by a big fall in prices as higher oil prices encourage more supply and kill more oil demand and this time is unlikely to be any different.
The peace deal may not necessarily lead to a further fall in Australian petrol prices just yet – much depends on what happens to the fuel tax cut. At around $1.64 a litre they are below where they were before the War started! This reflects the $0.32 fuel tax reduction that is scheduled to end this month, implying a rebound to around $1.96 a litre if the tax cut is reversed. But as the decline in global oil prices over the last month gradually flows through the petrol price is likely to settle around $US1.75. In other words, up from pre-War levels but not significantly so and in the range of the last few years. Of course, it the fuel tax cut is continued petrol prices could drift another 10-20 cents or a litre lower from here as the oil price fall flows through. Economics suggests that the fuel tax cut should end as scheduled – as it adds to the Budget deficit, will only boost spending when the RBA is trying to slow it and there are better ways to help those who need it. But the Government is under pressure from One Nation promising to halve fuel excise for 3 years.
The RBA provided no surprises and left rates on hold as three rate hikes in a row and signs of softer demand growth provided scope to pause and assess. However, this should not be seen as the top with the Reserve seeing the growth slowdown as what is needed, underlying inflation still rising in line with its forecasts, inflation still being too high and likely to remain so for some time and noting that its prepared to hike further if required. What’s more while the US/Iran peace deal is good news the RBA is likely to remain wary of the second-round flow through to inflation from the oil supply disruption that “will take some time to resolve”. We are continuing to allow for a further rate hike in August and have another one pencilled in for November reflecting the still rising trend in underlying inflation and risks that it will take longer to control.
Our view on shares hasn’t changed and we continue to see them providing positive returns this year, albeit with more volatility. The combination of sticky inflation, an upwards drift in central bank interest rates, worries about an AI bubble, huge US IPOs, political uncertainty around the US mid-terms and lingering Iran risks even with the deal are likely to continue to result in a volatile ride with a high risk of yet another correction. But continuing economic growth, solid profit growth and Trump likely to pivot somewhat to more consumer-friendly policies ahead of the mid-terms should result in okay overall returns.
In Australia, the Federal Government announced carve outs for its capital gains tax and trust changes. These basically increase the number of small businesses eligible for a 50% CGT concession by raising the revenue threshold from $2m to $10m, allow start ups meeting an “innovative business” definition with less than $50m revenue to retain the 50% discount, exempting donations from trusts from the 30% minimum tax and exempting testamentary trusts from the 30% minimum tax rate. The changes are welcome and should have been included in the Budget announcement to head off a lot of criticism. However, it’s debatable whether the changes go far enough. In particular the rules around innovative start-ups look very onerous with a cap on capital gains which looks too low – particularly once allowance is made for many such startups ultimately failing. And the change to CGT still apply in relation to share investing which by biasing share market investors towards income could mean less capital available for growth stocks. A failure to allow for the smoothing of capital gains for tax purposes unlike the old Keating model will also lead to inequitable outcomes where someone earning the same income as a salary earner but via a lumpy capital gain will end up paying a lot more tax.
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