Much of Fifth Set’s investment philosophy is drawn from the academic research findings of University of Chicago Professor Eugene Fama. A 2013 Nobel laureate in Economics, Professor Fama was recently interviewed for a New York Times article “Talking War and Market Volatility With a Giant of Economics”.
With increased market volatility reflecting the continuing impacts of Covid, inflation and the Ukraine war, Professor Fama was asked to reflect on the current market environment. Below are a few highlights from the article as well as implications for how Fifth Set manages client portfolios.
On market predictions:
Fama: “I don’t read any of that. It’s investment porn…that stuff isn’t based on deep research. What do they really know?”
Fifth Set’s view – Market predictions, whether made by investment bank strategists or CNBC talking heads, are a waste of time. No one can consistently predict market returns because returns are driven by new information. The disciplined Fifth Set approach is to acknowledge that we do not know what the future holds and design portfolios that will deliver acceptable returns regardless of the market outcome.
On market volatility reflecting efficiency, not irrationality:
Fama: “Basically, we’re in a period where we have had an injection of uncertainty into the world, so speculative prices are going to go up and down in response,” he said. “People are continuously trying to evaluate information. But it’s impossible for them, given the amount of uncertainty that’s out there, to come up with good answers.” “But that doesn’t mean the market is inefficient,” he added. “Markets can be rational without politics being rational or people always being rational. The problem with pricing is a question of how much is knowable right now. How’s this Russia thing going to work out? Who knows?”
Fifth Set’s view: Markets are efficient because they continuously incorporate new information by adjusting prices. In periods of crisis, increased market volatility is a reflection of markets incorporating new information with less certain outcomes such as the Ukraine War.
On stocks in the long term:
Fama: “(Professor Shiller has found that, adjusting for inflation, it took two decades for the stock market to come back from its losses in the Great Depression). “Yes, but two decades might not be enough. In the future, it could be longer. Really, there’s no answer. You just don’t know. There’s always a risk it will take longer than your lifetime.” “The faint of heart may not want to hear this,” he said, “but the stock market can always go into a deep and long decline.”
Fifth Set’s view: Stocks, over time, will probably outperform safe assets such as high-quality fixed income and cash, but not definitely. That is why it always makes sense, even for very long-term portfolios, to hold at least some portion in safer assets.
On ‘good’ or ‘bad’ times to invest in stocks:
Fama: “…there is always risk in the stock market, always. It never goes away. People have to remember that.”
Fifth Set’s View: Stocks are always risky. What changes over time is the perception of risk. When markets are rising, investors’ perception of risk declines and vice versa. The disciplined Fifth Set approach is to always maintain target portfolio allocations regardless of market conditions.
Fifth Set’s focus on implementing objective research from academia helps us apply a disciplined approach to managing our client portfolios. In turn, our clients benefit through a better investment experience that instills confidence and helps them sleep better at night.