Be Aware of History

Introduction

My basic belief is that you can scratch an analyst and a historian will bleed. The good professors and scientists at Caltech tell me that our memories are a critical decision-making part of our brain. Thus each of us are to some extent historians. On this weekend before the historic Brexit referendum I thought it would be useful to selectively search history for clues as to future wise investment moves.

Lowest Interest Rates in 5000 Years

In Mesopotamia about the first recorded interest rate was 20%. That was the same rate charged in Babylon in 1772 BC as well in Italian cities about 1150 AD. The highest recorded rate was in 539 BC of 40+% at the time of King Cyrus taking Babylon. What may have been a spur to colonization of the US, English interest rates were 9.92% in the 1700s. To show the volatility in the US, our rates were about 1.85% during WWII. By the 1980s rates rose to 15.84% compared to the 0.25-.50% the Fed is using currently. The sources for this and other similar data are the Bank of England, Global Financial Data and a book by Homer and Sylla entitled “A History of Interest Rates.” Dick Sylla an NYU professor for many years has been the chair of the Museum of American Finance whose board I served on. The purpose of showing the historic swings in rates is to alert investors that a future surge in rates may not peak in the mid single digit range.

One of the very best chart readers I know suggested to me that the continuously offered 30 year US Treasury Bond has possibly reached a thirty-five year peak in a move that began in 1981. I am conscious that Treasury officials, the SEC, and various hedge fund operators are concerned about the illiquidity in portions of the Treasury market. This may well be the reason that the Treasury is not materially expanding the duration of the US Government Debt structure. As investor for clients and my family in equity funds I find that any potential disruption in the most senior market can be unnerving. The modern theory of equity investing is based on the floor created by the risk free interest rate on US Treasuries. Perhaps it could be suggesting that we should be looking for a sub-basement below the floor!

Historic Perspective on Brexit

I do not know which way the vote will go, but the way I look at the polls as of now the “leaves” appear to be winning. Regardless on the outcome unless there is at a least ten point spread, it is my belief there will be other elections in the UK and Europe both for leaving and joining. From a historic point of view one can see that Common Market is just another attempt at European unity which goes back to the time of Julius Caesar. All of these have failed in the end for two intertwined reasons, (1) lack of confidence in the leadership particularly and (2) the provision of defense of the life of the homeland. During the Spanish Civil War there was great fear of the “fifth column” of enemies in civilian clothes creating great damage. Today throughout the world this fear is again present in the inability to properly screen immigrants or perhaps their children.

In the developed world these fears (along with concerns about the future economic outlook) are leading to a decline in the rate of marriage as well as fertility. Demographic trends take a long time to develop and change slowly. In time these trends play a political role and the referendum and the coming US elections could be influenced beyond the political leadership’s expectations.

Risk Management

On a recent trip to Europe one of my good analytical friends who is now a US citizen but was born elsewhere was anxious to return to the US, a land of risk-takers. By implication he was decrying that most of the Europeans that he was talking with were not attuned to taking risks. I believe that the US has benefited from the fact that many of our ancestors had to take big risks to get here. But we are not as much gamblers as other people are. What we risk is our hard labor against long-term goals.

One liberal arts university whose board I sat on recognized the need to offer business related courses to keep its attendance up to the level that they could afford the professors and staff. The would-be business professors came to the board and were outlining what they wanted to teach. In one case they wished to teach risk avoidance. I demurred. To me they should teach risk assumption and therefore risk management. Our whole private and public equity culture is based on wisely seeking risk assumption at the right price and conditions. To an important degree this drive is missing in many countries, but not others -  particularly in Asia.

Getting Bullish

The essence of risk management is to take on risk when others shed it as much as possible or are reluctant to commit to a future. While both Brexit and the high quality bond market may prove to be hurdles, they are not absolute impregnable walls. When too many are in their foxholes or trenches, this could be the time to advance. Clearly if bad things happen there could be cheaper entry points if one is not too petrified to move. Thus, I would urge long-term oriented investors to begin or increase their equity investing. If they are having trouble finding the appropriate funds to use, I will be glad to help for awhile.

Question of the week: Will the outcome of Brexit change your equity allocation by more than 20%? 

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