Investment Insights Newsletter

October Commentary
Play To Win, Play Not To Lose or Just Play Smart

Know the Score

In 1999, at The Open Championship (The British Open, as it is known by many), Jean van de Velde, a French journeyman golf professional, held a seemingly insurmountable lead as he marched to the last hole of the tournament. All he had to do was score better than a seven on the par-four 18th hole, sign his scorecard, and he would be declared the “champion golfer of the year” (proclaimed with a thick, yet stately, British accent). His victory would be one for the ages and signal the first major tournament win by a Frenchman in more than 90 years. Vive la France! Shockingly, on perhaps the grandest golf stage of all, Jean van de Velde made a seven on the last hole following a series of horribly misguided shots and eventually lost in a 3-man playoff. Touché and adieu, mon ami. It will forever be my contention that Monsieur van de Velde lost in 1999 because he did not “know the score,” forgot what stage of the game he was in, and took too many unnecessary risks. Many of the events that led to van de Velde’s collapse are similar to the challenges investors frequently face, and the outcomes often can be the same.

“What on earth are you doing? He's gone ga-ga. To attempt to hit the ball out of there is pure madness." — Famous British golf commentator Peter Alliss, speaking about Frenchman Jean van de Velde during the 1999 Open Championship at Carnoustie.

Risk Begets Reward? Unnecessary Risk Begets Disaster?

In the investment industry, we talk a lot about risk and reward. Over time, the two should be perfectly positively correlated — the more risk you take, the more reward you should receive. Likewise, the opposite is also true — less risk, less reward. While most people recognize and accept this concept in the world of investments, this “risk-reward paradigm” also applies in real life. Just ask our protagonist; he took too much risk, too late in the game, and it cost him victory. I would further argue that he was complacent, perhaps even smug, and overconfident that he had the championship won.

Setting aside van de Velde’s unfortunate failure for just a minute, the American way of life has engendered a culture that rewards independence, competition, work, creativity, entrepreneurial spirit, initiative, and optimism. This has immeasurably benefitted our society and economy as Americans have had to rely on themselves for success. Said differently, we have had to take, and have been allowed to take, more risk than many other cultures. For this reason, the U.S. ranks at the top of the list for both entrepreneurialism and, you guessed it, stock ownership. Not surprisingly, the U.S. controls an estimated 30% of the world’s collective wealth despite representing only 4-5% of the global population. By that measure, I would conclude the more risk a society takes, the wealthier it will be. While entrepreneurs, “risk-takers,” and investors lead this charge, the resulting rewards for this risk can lead to variations in wealth distribution. This happens for a very simple reason: the more wealth you have, the more risk you can afford to take.

Let us consider Jeff Bezos, the CEO of Amazon. His current estimated net worth is around $201 billion and $175 billion is in one stock — Amazon (AMZN). This lone holding represents almost 90% of his net worth meaning that by every traditional investment metric, Mr. Bezos has an extremely non-diversified and risky portfolio. What would happen if the value of AMZN were to fall by 25%? That’s right, Mr. Bezos would still be worth around $155 billion, which is roughly the GDP of Algeria! While that might seem ridiculous and unfair, what is the alternative, to not allow Bezos to have so much money? At first blush, that might seem appealing to many; however, that logic falls apart quickly if Bezos is somehow disallowed the rewards for the risk he takes. Intuitively, he would take less risk moving forward. No more Amazon deliveries? No more space flights? Is that a good thing for society? I do not know about you, but I would miss seeing Brandon, my Amazon delivery driver, several times a month

Let The Big Dog Eat!!

Throughout the years, many have speculated whether van de Velde knew he was three strokes ahead with just one hole to play. However, as an experienced competitive golfer myself, I am absolutely convinced he knew. As it relates to investors, I have witnessed occasions when investors with seemingly large leads pull out their driver when all that is required to win is to keep the ball in the middle of the fairway. Typically, these investors have not paused to know the score and continue their strategies focused on building a bigger lead. Investing, like golf, is a competition. The obvious difference — an investor’s only opponent is the self-imposed goal he or she establishes for now or the future. Unfortunately, many investors lessen the chances at victory because they have not engaged a competent caddie (a trusted advisor) to give them advice. With that being said, how did van de Velde’s caddie not try to tackle him during this infamous and tragic series of events? Wrong sport, I know, but come on, man, do something to save your guy from his own bungling mistakes! 

Historically, the simple formula for investment success has been protect the downside, and the upside will take care of itself. While the formula is simple, it is not easy. Protecting the downside does not mean attempting to avoid the downside; that is likely a formula for failure. Mr. van de Velde would most likely not have been in a position for victory if he had not taken calculated risks along the way in the previous 71 holes of the championship. Rather, protecting the downside is about never being forced to turn a potentially temporary decline into a permanent loss, which most often happens when time runs out. Our tragic hero met his demise by making the wrong decisions at the absolute worst time. 

“The greatest danger occurs at the moment of victory.” — Napoleon Bonaparte 

Just like golf, the markets always represent a diverse set of opportunities and risks. Today, the fundamental market opportunity remains essentially the same as in the past year: the worst of the pandemic is behind us, with exceedingly less permanent damage to the economy than initially feared. However, some risks are becoming more evident, as a range of bottlenecks have emerged with the potential to dampen economic growth moving forward. While issues of supply chain disruptions, inflation, higher taxes and tighter monetary policy remain, we are encouraged by the strong corporate earnings season as companies have reported earnings that are growing at the third-highest rate since 2010. With that said, one of the biggest hazards on our investment horizon appears to the supply chain debacle. 

That Supply Chain ‘Thingamabob’

Before COVID-19, how often did you think about, much less discuss, supply chain bottlenecks? After all, what was there to think about; somehow stuff just ended up on the shelves. It all just happened, right? These days, if you are lucky enough to find your favorite product in stock, you are probably paying more for it than you were not so long ago. The most cited reasoning is that supply chain bottlenecks are driving up costs throughout the system. Makes sense from a theoretical supply-demand standpoint, but maybe there is another reason we are struggling with the supply side of the equation. 

The most compelling explanation I have found is given by Scott Lincicome, at the Cato Institute. In his article titled “America’s Ports Problem is Decades in the Making,” he cites a report that shows that not a single U.S. port made the Top 50 of ports worldwide in terms of efficiency. Not one! In fact, the two biggest container ports in the U.S., the Port of Los Angeles and the Port of Long Beach, which control much of our foreign trade, staggered home at 328 and 333 respectively, out of 351 ports in the survey. So basically, our primary ports in handling trade are barely “on par” with those found in Tanzania and Kenya. Even more telling, 50% of our trade with Asia flows through, you guessed it, the Ports of Los Angeles and Long Beach. Putting it altogether, most of our goods flow through ports that are ranked as two of the least efficient ports in the entire world. Now, throw in a black swan event like the pandemic, and the obvious outcome happens — bottlenecks throughout the entire country. On the surface, the pandemic is the main cause of the shipping crisis and the related pain we are feeling in the U.S. economy. Add in some wild swings in global supply and demand—and the players’ inability to snap their fingers and add new ships, warehouses, trains, or maybe even workers— and these pressures will continue for the next several months and into 2022.

Despite blustery headwinds, the stock market has proven resilient and shown once again an incredible ability to heal itself, as the last two months have illustrated. The month of September fell victim to investor complacency, a proverbial wall of worry, and just like that the market was down nearly 5%. However, the month of October, which has historically delivered powerful blows to investors, including the 1929 market crash and Black Monday in 1987, surged upward 6.9% on the back of strong corporate earnings and the ability of companies to pass along higher input costs. It is not so bad playing into the wind — take more club and swing easier. 

Summing It All Up

Unfortunately, many investors cannot define what financial victory looks like, and for those who can, it is sometimes terribly difficult to declare it. For some, the thrill of winning is often more fun than acknowledging victory, so they overconfidently continue to play the same game. It is critical for investors to clearly understand what success looks like to them, and to “know the score. If they are fortunate enough to be able to declare victory, pause and revel in their success. If they get into trouble from a wayward shot, play back to the safety of the fairway and do not make things worse by trying to hit a miracle shot out of the woods. And for some, it may be time to start anew from a different set of tees! For many, it may require hiring a competent caddie that will help save them from themselves. 

The decision Jean van de Velde made to hit his driver on the final hole of the 128th Open Championship has been vilified in golfing lore, though further complicating things by not playing back to the safety of his own fairway should elicit the harshest criticism, in my opinion. He had already proven himself to be a skilled golf professional as his aggressiveness and execution throughout the tournament had contributed to his large lead. In retrospect, maybe van de Velde’s success in birdieing the 18th hole in two of the three previous rounds proved to be a mental curse. Sadly, he lost sight of the ultimate prize and the compounding of his poor, ill-timed decisions demonstrated the risk, far outweighed the reward. The reward for being right was to win by three (or more) strokes. The risk for being wrong was to not win at all. C’est la vie, Monsieur van de Velde, c’est la vie. 

Au revoir until next month and be sure to listen to First Forward Podcasts for more financial insights.

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Past Editions

September 2021 Commentary

August 2021 Commentary

July 2021 Commentary

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