Caltech Data Heretics Go To Track For Inspiration

Summary

• The racetrack is the leading source of my security analysis and investment career thinking.
• The building blocks of our thinking rests on data, and it is often believed with religious fervor.
• A careful analysis of the data requires a probing mindset for validation and adjustment.

One of the luckiest occurrences of my life was being asked to join the board of Trustees at the California Institute of Technology (Caltech). Participating in board/committee meetings, as well as the informal gatherings, has been one of the great learning experiences of both my and my wife's lives. I had not focused on the thinking process leading to the 39 Nobel Prizes awarded to Caltech scientists until this weekend. Ruth and I watched a podcast hosted by fellow trustee Rich Wolf on "The Making of The Lonely Idea", one of several podcasts covering a few of Caltech's scientists outlining their thinking and discoveries. On the broadcast a few realizations became clear to me:

1. Some of these great minds drew inspiration from the racetrack which is the leading source of my security analysis and investment career thinking.
2. The building blocks of our thinking rests on data, and it is often believed with religious fervor.
3. A careful analysis of the data requires a probing mindset for validation and adjustment.
4. Sound thinking must be anchored in the real world of human experience.
5. A driving humility that accepts the reality of what is not knowable, as well as a realization of how little we individually know.

This was a particularly good weekend to focus on the investment implications of Friday's surprising announcement of job growth in the private/commercial sectors, and a much smaller than expected rise in unemployment. The good professors at Caltech would first focus on the generation of the data that led to the burst of enthusiasm for stock prices on Friday. The enthusiasm resulted from a series of global occurrences, including China's recovery from its shutdown and the announcement of massive US and European stimulus for their economies, to be paid largely by wealthy members for the benefit of those less fortunate.

For the purposes of this discussion I will focus on the US scene as it is the largest portion of most of our subscribers' wealth and consumption. Nevertheless, few of us lack exposure in our investing and consumption to the influences beyond our borders. It is critical we appreciate that we are living in an incredibly fast and evolving situation as the data is flashed to us.

The employment/unemployment report for "May" was for the week ended May 12th. In most months, a mid-month read is a reasonable summary glance for the entire month. However, this is not the case for this report. During May and June, the US, Europe, and Japan have been coming out of a COVID-19 lockdown. With good reason, private citizens have been reluctantly exposing themselves and their families to more contact with the outside, resulting in more people normalizing every day. Consequently, I believe the numbers for the second half of May will be materially more favorable than those of the 12th of May. With the Northeast and California coming online in June and July the employment numbers will get even better.

Humility
One of Caltech's regular teaching lessons is that there is something to learn from every experiment, typically with more learned from those that did not deliver on their objective. (With a bunch of losing betting tickets and occasional market losses I have a reinforced need for humility.) While we never truly know what the future will hold, the breadth of today's possible outcomes is extremely wide. In talking to people struggling to make financial plans for the fall and next year, it becomes clear that the probabilities concerning the direction of prices is currently more uncertain.

Some see an initial a wave of price declines, due mostly to retail/office space rentals and the liquidation of existing finished goods inventory. This appears to be a short-term view, as almost every serious person I chat with expects prices to rise in the future. An interesting aspect of these discussions is that they initially expect the focus to be on a limited number of critical items purchased at higher prices.

When asked about other prices, I am often met with "Oh, I did not think of that, but it should be added to the list". At the end of these discussions the roster of price increases is considerably larger than the list of expected price bargains.

The key to future prices is the expected level and nature of demand. In assessing this I believe I need even more humility. The consequences of first and future waves of COVID-19, as well as geo-political considerations and habit changes, suggests that as we climb out of our foxholes people may see their lives, jobs, and homes very differently than in the past.

Financial Security
One important area of concern is the understandable desire for financial security. In our own minds we build our own fortress (prison). Until recently, many felt their jobs were the foundation of their security and this was particularly true for those who worked for large organizations. We have seen many of these employment centers "Right-sized" and many are threatened by it coming. Beyond what we earn from our labor, many count on individual and/or group investments: pensions, 401ks, 403bs, Social Security/Medicare, etc. Except for low earners, none of these are impregnable, particularly regarding high inflation.

While stocks may be attractive to individual investors in the long-term, they are likely to be more volatile, with the cushions provided by floor specialists and contra-cyclical investors getting smaller. The price of gold and gold mining shares is signaling materially higher inflation. Even if the "gold bugs" are only half right, the biggest surprise to many may be the loss of purchasing power from owning "high quality" bonds.

The natural reaction to these concerns is to build ones own financial fortress, which has historically become a prison due to the lack of mobility. Stock markets in many countries are currently signaling just the opposite, with increased speculation, waves of new IPOs, and a rush into private equity, or its disguised companion private credit.

What to Do?
My investment views rests on Caltech's practices and my track and investment experiences. Caltech's 300 faculty and less than 2500 undergraduates, graduates, PhD, and Post Docs are always examining perceived knowledge and looking for a deeper understanding of the world as it exists. More experiments and more mistakes equal more learning, which combined with humility produces good results. Not having the breadth of Caltech, I use a twin approach.

For clients and family, we build portfolios of funds, mostly equity. The portfolios use concentrated/narrowly focused funds, along with some broad-based funds. In personal accounts we occasionally add individual stocks to provide exposure to investment areas insufficiently covered in our funds. The big difference in our approach is time horizon, which when successful is for multiple generations.

Question:
Is your investment thinking evolving? If not, why not?

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.