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Summary

  • Two distinct viewpoints are currently defining the discussion as to how we should view the market rally that has taken place over the last five years.
  • These are the “romantic” and the “classical” perspectives, and they have widely divergent opinions between the two about how to approach today’s market.
  • Which of these two investor types are likely to be most successful when managing their portfolio and investment decisions in the current and future market environments?.

What is quality when it comes to investment markets? This is a question that has become particularly relevant in the years since the outbreak of the financial crisis. Two distinct viewpoints are currently defining the discussion as to how we should view the market rally that has taken place over the last five years. These are the "romantic" and the "classical" perspectives, and they have widely divergent opinions between the two about how to approach today's market. This raises an important question. Which of these two investor types are likely to be most successful when managing their portfolio and investment decisions in the current and future market environments?

"What makes his world so hard to see clearly is not its strangeness but its usualness. Familiarity can blind you too."

-Robert M. Pirsig, Zen and the Art of Motorcycle Maintenance: An Inquiry Into Values

On one side of the discussion are those that adhere to the "romantic" view. This is the Zen like belief that one should not needlessly worry about the market we are investing in today. Yes, a broad range of risk asset classes across capital markets including stocks (NYSEARCA:SPY), corporate bonds (NYSEARCA:LQD) and high yield bonds (NYSEARCA:HYG) have rallied strongly in the last five years since the end of the financial crisis, but in the romantic mind this is simply a confirmation that underlying economic and financial conditions are indeed significantly better. Prices at this moment are telling us everything that we need to know and the market will simply take care of itself in the future just as it has in the past. Thus, the answer to successful investing is to commit to the belief that all is well, allocate accordingly and hope for the best.

Unfortunately for those following the romantic view, all is not always well with investment markets. For since the turn of the millennium we have had two major bear markets that have twice cut the paper wealth of the romantic investor by at least half if not more. Not only have these dramatic episodes left the romantic investor with a feeling of peril at times, but they were also left at the mercy of policy makers including the U.S. Federal Reserve to rush in to try and fix the problem. Indeed, the Fed has managed to restore the markets to their previous form in the wake of the past two market breakdowns. But will they be able to do so again in the future? This remains to be seen.

"You look at where you're going and where you are and it never makes sense, but then you look back at where you've been and a pattern seems to emerge. And if you project forward from that pattern, then sometimes you can come up with something."

-Robert M. Pirsig, Zen and the Art of Motorcycle Maintenance: An Inquiry Into Values

On the other side of the discussion are those that follow the "classical" approach. These are your deeply rational investors that are monitoring, analyzing and dissecting the various signals and nuances offered by the economy and markets on a moment-to-moment basis. They have an encyclopedic knowledge of market history, have a deep understanding of the interconnectedness across global asset classes and are highly sophisticated in the art of data analysis.

Many investors diligently following the classical approach have found themselves profoundly frustrated in the years following the financial crisis. For while some adherents firmly believe the market engine is running well, many other classical investors find themselves repeatedly dumbfounded by long standing traditional market and economic relationships that seemingly no longer apply in the current environment. This likely explains at least in part why so many hedge funds have performed poorly over the last several years. It's not as though they have suddenly become ignorant to the intricate inner workings of the market cycle. Instead, the behavior of the current market cycle has deviated so widely from what is normally expected that it often defies traditional rationale. Perhaps these cynical classical investors will eventually be proven right as many were twice before in the past fifteen years. But to date they continue to be proven wrong in the current market cycle.

"Is it hard? Not if you have the right attitudes. It's having the right attitudes that's hard."

-Robert M. Pirsig, Zen and the Art of Motorcycle Maintenance: An Inquiry Into Values

So what then is the right approach? Is it best to be a romantic investor that lives in the moment and puts complete faith in the market that everything will be OK only to run the risk of enduring yet another major decline? Or is it best to be a classical investor that rationalizes all of the reasons why the ongoing rally makes no sense only to miss out on the additional upside that the market seemingly will not relent in providing?

The answer to whether it is better to be a romantic or classical investor is the following: Yes. The investors that are likely to perform best in the current and upcoming market cycles are those that are able to successfully appreciate and incorporate both the romantic and classical viewpoints into their portfolio management and investment decision making. What defines the truth as it relates to capital markets in the current environment can vary widely depending on one's personal perspective. But a dogmatic adherence to one particular approach can lead to the perception that truth and quality are badly disconnected at any given point in time, thus resulting in extended periods of frustration and dissatisfaction that the market is nowhere close to reflecting the reality they believe to be true. However, investors with the openness to incorporate and blend both the romantic and classical ways of thinking into their investment philosophy stand in the best position to succeed. For they remain grounded enough in their rational approach to minimize the unexplained and successfully manage against downside risk, but they also remain open minded enough to recognize that many things will take place in investment markets that defy reasonable logic and must maintain a degree of mental flexibility to capitalize on these opportunities regardless of whether they make sense or not. It is the investors that are able to successfully integrate both approaches that are likely to feel the greatest sense of harmony and satisfaction in their efforts.

Postscript

"But to tear down a factory or to revolt against a government or to avoid repair of a motorcycle because it is a system is to attack effects rather than causes; and as long as the attack is upon effects only, no change is possible. The true system, the real system, is our present construction of systematic thought itself, rationality itself, and if a factory is torn down but the rationality which produced it is left standing, then that rationality will simply produce another factory. If a revolution destroys a systematic government, but the systematic patterns of thought that produced that government are left intact, then those patterns will repeat themselves in the succeeding government. There's so much talk about the system. And so little understanding."

-Robert M. Pirsig, Zen and the Art of Motorcycle Maintenance: An Inquiry Into Values

A closing note on zen and the art of market cycle maintenance. Regardless of whether you are biased toward a romantic or classical approach, a broader structural problem continues to undermine the health of investment markets. One of the greatest shortcomings of policy makers in the years since the outbreak of the financial crisis has been their approach in resolving the problem. At the core of what resulted first in the bursting of the technology bubble and then the outbreak of the financial crisis is the rationality among monetary policy makers that they can directly control and manage the business cycle. This includes enhancing the expansions and minimizing the recessions. But such an approach leads to a structural imbalance and disharmony in the economy and markets that eventually needs to be resolved. Unfortunately, when the economy and its financial markets have entered into periods of breaking down, the response by policy makers has been to attack the effects instead of deal with the root causes. And as long as monetary policy makers remain steadfast to the same rationality that led us to the previous two crises over the last two decades, we are almost certainly destined to repeat this same dreadful outcome once again, perhaps at an even greater magnitude than before. And such is an outcome that comes at the expense of the peace of mind of all investors regardless of their romantic or classical ideologies.

Additional disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Source: Zen And The Art Of Market Cycle Maintenance