Saturday Night Reflections: Flipping The Bird To Marco Polo

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There are only three things that would kill an immortal investor in an index fund.

They are: natural disasters, disease, and/or politics.

I'm coining a new term: "political indexing."

Do you know why plain vanilla indexing works as an investment strategy? Because it saves people from themselves.

Active management is dead and so, increasingly, is the two-and-twenty model. If they can't beat the market, neither can you and to be perfectly honest, you shouldn't try. Just ask Vanguard founder John Bogle who, like the Rolling Stones' Keith Richards, is apparently an immortal. Here's what Bogle said in a webcast earlier this week:

Turnover in the stock market has gone from maybe 25% a year to 250% a year. And so people are doing more and more swapping back and forth with one another creating value for Wall Street and subtracting value from themselves.

The same thing -- very few people I think have thought about this -- the same thing is happening in the mutual fund business. When I was in this business at the beginning, the typical redemption rate was, let me just take a slight guess at this, was about 8% a year.

And that meant if you had 100 shareholders in the beginning of the year, eight would leave during the year. And now that redemption rate is up to 25% a year.

If you're contributing to that trend, you should stop.

You can't beat the market (NYSEARCA:SPY) picking individual stocks. By "you" I mean the collective "you."

Sure, some people will outperform over a given time period whether it's one hour, one day, or perhaps even over the course of a decade. Some of that outperformance will be attributable to skill, some of it to blind luck. But generally speaking, "seeking alpha" is a fool's errand. You can look for alpha all you want, but in the aggregate, over the long-haul, you aren't going to find it.

Fortunately for you, there's a bulletproof investment strategy that is infallible -- almost. When you buy a balanced index fund comprised of say 60% stocks and 40% bonds that collectively approximate the broad investment landscape, what you're essentially doing is betting on the continued survival of civilized society.

That's a concept I was mulling as I was meandering aimlessly around mid-town on Saturday (something I'm prone to do on weekends).

When you walk around Manhattan, you literally see the capitalist economy in action. That didn't stop in 2008. People still shopped. They still bought their morning coffee.

Let's assume your investment horizon is infinite. You are, like Keith and John, an immortal. Assuming society continues on a reasonably predictable path, you cannot lose in an index fund. Sure, there will be decidedly bad stretches, but if your investment horizon is unlimited, the only thing that matters is whether there's, i) demand for goods and services, ii) an economy that allows free enterprise to meet that demand, and iii) a vehicle for you to invest in all of those free enterprises simultaneously via indices that reconstitute periodically to reflect the broad market.

But there's a caveat (or three). That's why I called indexing with an infinite investment horizon "almost" bulletproof. There are only a handful of things that can usurp the three conditions mentioned in the preceding paragraph and here they are: 1) natural disasters, 2) disease, 3) politics.

Those three things and those three things alone have the ability to stop society dead in its tracks. All three have the potential to create a world where people no longer get their morning coffee and thus, a world where the most infallible of investment strategies fails.

Notice that of the three things mentioned, only one is ultimately under our control. Yes, we can help out the natural disaster situation by cutting down on fossil fuel use, but we can't stop an asteroid from hitting the earth (just ask the dinosaurs). We can develop all sorts of medicines but we can't outrun Mother Nature -- if ebola goes airborne tomorrow, we're all dead. Period.

But what we can control is politics. And the trend is starting to make me believe indexing would be a better strategy than elections. Consider the following quote from Citi's head of G10 FX strategy that I posted elsewhere this weekend:

The US presidential election came up frequently in recent travels. In Asia just about every conversation touched on the US election, as did many in Europe. The key takeaways are that most investors do not see much election risk priced in, but that there is a fear that a tightening of the Presidential race would raise fears of a trade war and put downward pressure on both US and foreign asset markets.

In case you have trouble reading between the lines there, it isn't Hillary Clinton they're talking about. Check out this screengrab from Bloomberg:

Folks, I'm not going to sugarcoat it: this is extraordinarily dangerous.

I've studied politics for nearly two decades and I'm not alone in sounding the alarm. This has nothing to do with Republicans and Democrats anymore. I'll be honest -- if House Speaker Paul Ryan had run for president in the US, I might very well have voted for him. I don't care one way or another about Republican or Democrat. I care about not doing something that threatens to destabilize a system that has allowed anyone invested in the US stock market to make an average return of between 7% and 9% reliably over a century.

I care about preserving a system that allows me to get my coffee in the morning and that would afford me the opportunity, if I were an immortal, to make between 7% and 9% in perpetuity until an asteroid blows up the planet.

Well let me tell you something: we're on the precipice of ushering in a political sea change that could very well jeopardize society as we know it and thus destabilize a prevailing order that allows for the consistent accumulation of wealth among interconnected, cooperative developed and emerging markets. Here's a quote from the above-mentioned Viktor Orban:

We think all countries have a right to decide whether they want to have a large number of Muslims in their countries. If they want to live together with them, they can. We don't want to and I think we have a right to decide that we do not want a large number of Muslim people in our country. We do not like the consequences of having a large number of Muslim communities that we see in other countries, and I do not see any reason for anyone else to force us to create ways of living together in Hungary that we do not want to see.

That, frankly, is nuts. That's a world leader that is effectively endorsing Donald Trump for president. What you need to keep in mind as an investor is that this isn't about Muslims or terrorism. This is about deconstructing a global trade regime that it's taken centuries to build. Have a look at this:

(Chart: BofAML)

As I noted on Friday, that represents societal backtracking. It's like flipping the bird to Marco Polo.

Here's some color from BofAML (my emphasis):

This shift in sentiment and looming risk of great trade barriers is happening in the midst of a substantial slowdown in the volume of global trade. There are several possible reasons for this unprecedented slowdown, but one unappreciated factor has been the steady rise in protectionism since the Global Financial Crisis. This is a disturbing trend that may develop into an increasing drag on global growth should electorates demand more protectionism and mercantilist policies. This is both ironic and unfortunate: while global trade deals often appear to be zero-sum negotiations, more global trade activity is a positive-sum outcome.

A Bloomberg poll of 1,000 US respondents in March of this year discovered that 65% favored more import restrictions to protect jobs, vs 22% who favored fewer restrictions to give consumers the most choice and the lowest prices. Yet at the same time, 68% polled would rather have a US-owned firm employing 1000 American workers in their community versus 23% who were willing to have a Chinese-owned firm employing 2000 US workers. Domestic ownership as well as domestic production is preferred in these surveys, even if - perversely - it results in substantially less employment overall.

Obviously, that is insane. Who cares whether the firm is Chinese-owned if it's employing 100% more people in your community? Those are real jobs that create real purchasing power that allow for the continuation and expansion of the very same capitalism that would allow our hypothetical immortal index investor to reap 7% to 9% returns forever, or at least until the world runs out of space for new Starbucks locations.

It's with that in mind that I propose applying the index fund model to politics. You, as a citizen of a civilized society, acquiesce to government by a broad coalition of "blue chip" politicians and their descendants; call it "political indexing" (Heisenberg trademark).

If you read this all the way through and are angry at the author I encourage you, as a rational member of the investor community and the human race, to compare commentary from German Chancellor Angela Merkel and rhetoric that emanates from AfD chief Frauke Petry who is rapidly gaining popularity.

That's why we need "political indexing." Because everyday people can't pick politicians any better than they can pick stocks. And they're on the verge of bringing about a 1939 redux.

Only this time, the good guys are also the bad guys.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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