Larry Sarb
As we approach the end of one of the most bizarre years on record, it might pay investors to reflect on a historical perspective. Hopefully, we can learn some valuable lessons. To my mind, there is no better author of such circumstances than John Kenneth Galbraith, the brilliant Canadian economist.
That the same threads recur “is of no slight importance,” Galbraith notes: “Recognizing them, the sensible person or institution is or should be warned.”
However, he goes on to observe that, “the chances are not great, for built into the speculative episode is the euphoria, the mass escape from reality, that excludes any serious contemplation of the true nature of what is taking place.”
Of the factors that occur repeatedly, he says, “the first is the extreme brevity of the financial memory.”
Having been in the investment business for more than 40 years, I have witnessed this occur repeatedly. It certainly is prevalent in today’s period. Many of today’s investment population, individual and institutional participants, simply weren’t around for, or aware of, events such as the crash of Oct. 19, 1987, the dot-com bubble or the financial disaster of 2008. And, as Galbraith notes, “There can be few fields of human endeavour in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.”
Here’s another Galbraith insight: “Uniformly in all such events there is the thought that there is something new in the world. In all speculative episodes there is always “an element of pride in discovering what is seemingly new and greatly rewarding in the way of financial instrument or investment opportunity. The individual or institution that does so is thought to be wonderfully ahead of the mob.”
Galbraith notes an important additional truth: “As to new financial instruments, however, experience establishes a firm rule…. The rule is that financial operations do not lend themselves to innovation.”
The creation of the first index fund in 1975 was a true innovation. The following appearance of Exchange Traded Funds (ETFs) in 1993 was a very successful takeoff of the original index but built upon the very same concept. The NYSE has about 2,400 companies listed while Nasdaq numbers about 3,300. Today, there are 6,970 ETFs traded on the U.S. exchanges with dozens of different structures and flavours. In this case, the idea of reinventing the wheel has grown to such an extent that there are more ETFs than publicly traded companies, an extreme example of an idea taken to excess.
Another warning, “All financial innovation involves, in one form or another, the creation of debt secured in greater or lesser adequacy by real assets…. All crises have involved debt that, in one fashion or another, has become dangerously out of scale in relation to the underlying means of payment.”
Welcome to the present. As of October 2020, America’s national debt had reached US$27 trillion. As of April 2020, debt as a percentage of GDP was 122 per cent. Ten years ago, that statistic was 84 per cent and 10 years before that, it was 58 per cent. The curve representing that statistic has gone parabolic. As Galbraith warns, excessive debt eventually can result in calamity.
Galbraith’s common denominators are clearly in play today.
I’m not telling you not to invest. I believe you can do so successfully, as long you remember to avoid the above listed sinkholes. Remember, an astute investor has to be part investor and part historian.
Our answer to not getting caught in the traps forewarned by Galbraith: stick with investments, especially in equities, which have strong balance sheets, predictable futures, huge sustainable moats around their businesses and characteristics of necessity (you can’t live without them). Whatever the crisis that arrives, your companies will still be standing.
One example today is the commercial insurance industry. What is most attractive is that the companies are trading at bargain prices, mainly due to a long period of weak underwriting pricing. Now, we are seeing a strengthening in pricing. Many of these companies have all the characteristics listed above with careful, conservative management in place. Their behaviour has been to avoid unprofitable underwriting, thus avoiding dangerous actions. With this important price shift, an increase in underwriting by these companies is underway. Companies like Fairfax, Berkshire Hathaway and Markel, all trading at what we believe are undervalued levels, offer investors a pocket of opportunity to invest while avoiding the Galbraith dangers.
Another example is Domino’s Pizza Group plc. Domino’s U.K. is part of the largest pizza franchise in the world. Delivery of pizza has grown during the pandemic, but had been expanding before that as well. The company is reasonably priced, especially when compared to its counterparts in the U.S. and Australia. It is a high-margin business as they only supply the ingredients to the franchisees, who are the ones putting up major capital investment. Again, we believe this is a business that heeds Galbraith’s warnings.
If you chose to ignore Galbraith’s insightful observations, you may fall victim to what he reportedly said many years ago : “The old generation must die off so a new set of idiots can make the same mistakes all over again.”
Larry Sarbit is a portfolio manager at Value Partners Investments in Winnipeg. He can be reached at lsarbit@vpinvestments.ca .
As we approach the end of one of the most bizarre years on record, it might pay investors to reflect on a historical perspective. Hopefully, we can learn some valuable lessons. To my mind, there is no better author of such circumstances than John Kenneth Galbraith, the brilliant Canadian economist.
© Provided by Financial Post J.K. Galbraith's A Short History of Financial Euphoria, published in 1990, deals with some of history’s most spectacular investment manias, stretching from the 17th-century Tulipmania up to the crash of 1987.
J.K. Galbraith is known for dozens of books on finance and financial history. A Short History of Financial Euphoria, published in 1990, deals with some of history’s most spectacular investment manias, stretching from the 17th-century Tulipmania up to the crash of 1987.
The must-read chapter is the second, titled “The Common Denominators,” which looks at the common threads that run though all these extraordinary events. Unfortunately, many of them are visible in today’s market.
J.K. Galbraith is known for dozens of books on finance and financial history. A Short History of Financial Euphoria, published in 1990, deals with some of history’s most spectacular investment manias, stretching from the 17th-century Tulipmania up to the crash of 1987.
The must-read chapter is the second, titled “The Common Denominators,” which looks at the common threads that run though all these extraordinary events. Unfortunately, many of them are visible in today’s market.
That the same threads recur “is of no slight importance,” Galbraith notes: “Recognizing them, the sensible person or institution is or should be warned.”
However, he goes on to observe that, “the chances are not great, for built into the speculative episode is the euphoria, the mass escape from reality, that excludes any serious contemplation of the true nature of what is taking place.”
Of the factors that occur repeatedly, he says, “the first is the extreme brevity of the financial memory.”
Having been in the investment business for more than 40 years, I have witnessed this occur repeatedly. It certainly is prevalent in today’s period. Many of today’s investment population, individual and institutional participants, simply weren’t around for, or aware of, events such as the crash of Oct. 19, 1987, the dot-com bubble or the financial disaster of 2008. And, as Galbraith notes, “There can be few fields of human endeavour in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.”
Here’s another Galbraith insight: “Uniformly in all such events there is the thought that there is something new in the world. In all speculative episodes there is always “an element of pride in discovering what is seemingly new and greatly rewarding in the way of financial instrument or investment opportunity. The individual or institution that does so is thought to be wonderfully ahead of the mob.”
Galbraith notes an important additional truth: “As to new financial instruments, however, experience establishes a firm rule…. The rule is that financial operations do not lend themselves to innovation.”
The creation of the first index fund in 1975 was a true innovation. The following appearance of Exchange Traded Funds (ETFs) in 1993 was a very successful takeoff of the original index but built upon the very same concept. The NYSE has about 2,400 companies listed while Nasdaq numbers about 3,300. Today, there are 6,970 ETFs traded on the U.S. exchanges with dozens of different structures and flavours. In this case, the idea of reinventing the wheel has grown to such an extent that there are more ETFs than publicly traded companies, an extreme example of an idea taken to excess.
Another warning, “All financial innovation involves, in one form or another, the creation of debt secured in greater or lesser adequacy by real assets…. All crises have involved debt that, in one fashion or another, has become dangerously out of scale in relation to the underlying means of payment.”
Welcome to the present. As of October 2020, America’s national debt had reached US$27 trillion. As of April 2020, debt as a percentage of GDP was 122 per cent. Ten years ago, that statistic was 84 per cent and 10 years before that, it was 58 per cent. The curve representing that statistic has gone parabolic. As Galbraith warns, excessive debt eventually can result in calamity.
Galbraith’s common denominators are clearly in play today.
I’m not telling you not to invest. I believe you can do so successfully, as long you remember to avoid the above listed sinkholes. Remember, an astute investor has to be part investor and part historian.
Our answer to not getting caught in the traps forewarned by Galbraith: stick with investments, especially in equities, which have strong balance sheets, predictable futures, huge sustainable moats around their businesses and characteristics of necessity (you can’t live without them). Whatever the crisis that arrives, your companies will still be standing.
One example today is the commercial insurance industry. What is most attractive is that the companies are trading at bargain prices, mainly due to a long period of weak underwriting pricing. Now, we are seeing a strengthening in pricing. Many of these companies have all the characteristics listed above with careful, conservative management in place. Their behaviour has been to avoid unprofitable underwriting, thus avoiding dangerous actions. With this important price shift, an increase in underwriting by these companies is underway. Companies like Fairfax, Berkshire Hathaway and Markel, all trading at what we believe are undervalued levels, offer investors a pocket of opportunity to invest while avoiding the Galbraith dangers.
Another example is Domino’s Pizza Group plc. Domino’s U.K. is part of the largest pizza franchise in the world. Delivery of pizza has grown during the pandemic, but had been expanding before that as well. The company is reasonably priced, especially when compared to its counterparts in the U.S. and Australia. It is a high-margin business as they only supply the ingredients to the franchisees, who are the ones putting up major capital investment. Again, we believe this is a business that heeds Galbraith’s warnings.
If you chose to ignore Galbraith’s insightful observations, you may fall victim to what he reportedly said many years ago : “The old generation must die off so a new set of idiots can make the same mistakes all over again.”
Larry Sarbit is a portfolio manager at Value Partners Investments in Winnipeg. He can be reached at lsarbit@vpinvestments.ca .
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