PWA 2018 Year-End Letter, Part 1: What Makes Us Tick

I’ll begin 2018’s year-end letter as I did 2017’s, with a brief synopsis of how we operate here at PWA.

For starters, here are what we believe to be the essential characteristics of the best money managers:

1. A passion for macro economics and market history
2. A firm understanding of intermarket relationships
3. A firm grasp of global macro and geopolitical developments
4. An obsessively strong work ethic
5. The ability to transcend his/her ego and political preferences
6. An understanding of and appreciation for the uncertainty of markets
7. A flexible and open mind

While all of these qualities are, again, essential, 2018 pounded home the hugeness of numbers 6 and 7.

While reviewing last year’s letter I realized, frankly, that the bulk of its Part 1 is the definition of timeless and, thus, every bit as relevant today as it was a year ago. So, forgive the repetition, but — given the timelessness of a message that was borrowed mostly from a 1923 classic on investing — here it is, save only for the third paragraph, again:

Our ongoing study of market history often immerses us in the stories of the great investors of the past. For me, Jesse Livermore, the “boy plunger” of the late 19th/early 20th Centuries, has to be the most intriguing, and instructive. While I’ve consumed a number of books on Livermore, his life and his methods, Edwin Lefevre’s 1923 classic Reminiscences of a Stock Operator is the most captivating. I highly recommend it!

In his willingness to at times share himself with a trusted journalist, Livermore left the world with wisdom that will endure for as long as there are markets to trade. I’ll just scratch the surface with the following.

The first quote below exposes the subjective risk of market assessment. I.e., what constitutes bullish or bearish conditions (the present conundrum)? That’s a central question we’ll be exploring in the sections to follow:

“Not even a world war can keep the stock market from being a bull market when conditions are bullish, or a bear market when conditions are bearish. And all a man needs to know to make money is to appraise conditions.”

He was acutely aware of the habits of the investors and traders around him. He had to be, for he knew that the whims of ego-driven, emotional and impatient individuals at times created the most profitable market setups. Plus, they forever reminded him of the many ways not to trade markets:

“It is the way a man looks at things that makes or loses money for him in the speculative marketsThe public has the dilettante’s point of view toward his own effort, the ego obtrudes itself unduly and the thinking therefore is not deep or exhaustive. The professional concerns himself with doing the right thing, rather than with making money, knowing that the profit takes care of itself if the other things are attended to.

If I said to the average man “sell yourself five thousand steel” he would do it on the spot. But if I tell him that I am quite bearish on the entire market, and give him my reasons in detail, he finds trouble in listening. And after I am done talking he will glare at me for wasting his time expressing my views on general conditions, instead of giving him a direct and specific tip — like a real philanthropist of the type that is so abundant on Wall Street, the sort who loves to put millions in the pockets of friends, acquaintances and utter strangers alike.” 

And, in the end, he learned that patience was an essential ingredient to his success:

“After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this:  It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight!”

We can’t express enough — per the following excerpt from an earlier blog post — how we sympathize with Livermore’s point: “The professional concerns himself with doing the right thing, rather than with making money, knowing that the profit takes care of itself if the other things are attended to.” 

Earlier this year, after playing basketball, I stumbled onto an analogy that I believe best describes how we approach the managing of client portfolios. Which, by the way, also describes how we can sleep at night while accepting such a colossal responsibility. Here’s from our May 21 blog post:

I play a lot of basketball, and, as my son and the dudes I play with will attest, I like to attempt three-pointers. In that success enhances the enjoyment of virtually any endeavor, I knew from the start (my late start [not surpassing the 5’5″ mark till after highschool and, thus, being a wrestler during my formative years]) that if I was to score enough to justify my itchy trigger finger, I had to learn good shooting fundamentals. While I’m fully aware that 100% from the field is infinitely beyond my reach, I know that if I can stay in rhythm, if my form is sound and if I practice good shot selection, my odds of maintaining a respectable enough percentage to keep me from being the lowly last pick come time to select the teams increase dramatically.

Different players bring different talents to the game. There’s a young man we play with, we’ll call him Bartholomew (just in case he happens to stumble upon this blog post) who possesses exceptional ball handling ability and plays the point beautifully. Surprisingly, however, his outside shooting leaves much to be desired. So much so that when he launches a three his teammates cringe; hoping the ball finds nothing but air. Now why would his own teammates want Bart to miss his shot, in embarrassing fashion no less? Because they know that if he drains it, their odds of winning will decrease exponentially.

You see Bart believes that a shot that goes in has to be a good shot. Therefore, when he makes one he believes that he possesses the fundamental makings of a good shooter — and good shooters shoot. So he shoots and he shoots and he shoots and, in reality not having mastered good shooting fundamentals, he misses and he misses and he misses and, alas, his team loses.

We can sum up basketball shooting as follows. There are:

1. Good shots that go in.
2. Good shots that miss.
3. Bad shots that miss.
4. Bad shots that go in.

#1’s are great. #2’s are fine, unavoidable, and possess a liveable probability rate. #3’s, while costly, are the most predictable and, therefore — being costly — should be readily avoided. #4’s — as explained above — are an utter curse!

Here’s my point:

We can sum up investing as follows. There are:

1. Good investments that make money.
2. Good investments that lose money.
3. Bad investments that lose money.
4. Bad investments that make money.

#1’s are great. #2’s are fine, unavoidable, and possess a liveable probability rate. #3’s, while costly, are the most predictable and, therefore — being costly — should be readily avoided. #4’s: I can’t think of a worse case scenario than a new investor hitting a #4 right out of the gate. The perverse feedback from that experience could absolutely send him or her to the poorhouse — as he or she might think that he or she’s discovered a high probability investing method and chalk up the subsequent string of losses to rotten luck. I.e., believing what are in reality #3’s to be #2’s. The emotional imprint from that early “success” may indeed last longer than his or her capital.

Bottom line, while good investments can, and often do, lose money, if we take only shots where the setup makes good sense — i.e., if we take only good shots — and we take them from multiple angles and distances (diversify), we believe that we give our clients the absolute best odds of achieving long term investment success.


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