- Market Commentary
- By Jack Ablin
- September 24, 2019
Investing in an Era of Short-Termism
Short-termism is a perpetual temptation: the inclination to benefit today at the expense of the future is a vulnerability of collective human nature. We see this play out daily in market behavior, in tactical rather than strategic policymaking, and in investing with how the cards are being dealt, and not necessarily how they should be arranged. Monday’s UN Climate Action Summit gives me an opportunity to discuss short-termism as it affects the current investment environment. Today’s impetuous policymaking environment forces long-term investors to behave like traders, focusing on headlines instead of data.
Short-termism as a deeply rooted urge is exemplified by the “Marshmallow Test”, which demonstrates the difficulty of delaying gratification. The study, designed by Stanford professors Mischel and Ebbesen in the late 1960’s, offered children around the ages of four and five the choice between one marshmallow immediately or two marshmallows if they waited an unspecified amount of time (in fact, about 15 minutes), during which the tester left the room and the child was left alone with the tempting first marshmallow. Researchers found that children who were able to restrain themselves and hold out for the second marshmallow when the tester eventually returned to the room had better life outcomes, including higher SAT scores, than those children who couldn’t resist scarfing down the single treat.
Which brings us to climate change, perhaps the ultimate test of delayed gratification. The challenge of climate change is that it asks all of us living today for near-term sacrifice, like shifting away from fossil fuels, in exchange for benefits we may never reap in our lifetimes. As UN diplomats converge on New York this week, climate change is at the top of their agenda. More than 60 heads of state spoke at Monday’s Climate Action Summit, with the United States putting in only a brief token appearance. The theoretical benefit of sacrificing today would be maintaining and improving the quality of life over the long run. We have a long way to go, because we can’t even get past partisan bickering about plastic straws. President Trump criticized a plastic straw ban recently imposed by Florida lawmakers, and the Trump 2020 re-election campaign responded by selling Trump-branded plastic straws as an alternative to “liberal paper straws”. Last Friday, the Office of the US Trade Representative exempted Chinese plastic straws from tariffs. Take that, sea turtles!
On the bright side, attitudes toward climate change and toward the environment are evolving, particularly as baby boomers inevitably cede power to younger Americans. In 2020, for the first time, the youngest generations (both Millennial and iGen – born in or after 1997) are projected to make up the largest proportion of registered voters. A 2018 Gallup analysis found a “global warming age gap”: 70 per cent of adults aged 18 to 34 said they worry about global warming compared to 56 per cent of those aged 55 or older.
Sacrifice is of course possible. Throughout world history, societies have made sacrifices in the near term to secure a better future. For example, America’s Greatest Generation – those born between 1900 and 1924 – suffered the Great Depression and fought in World War II. For them, sacrifice and deprivation were a way of life. Their children, by contrast, find sacrifice unpalatable. Under the regime of the Baby Boom Generation, America’s federal budget deficit surpassed $1 trillion and, except for three months in 2018, monetary policymakers have kept the punchbowl out throughout our 10-year expansion. The one similarity between the 1940s and today is America’s debt-to-GDP ratio: it now rivals the level reached at the end of World War II.
What does this imply for investors? Dance while the music is playing. Policymakers who are willing to pull out all the stops to keep our expansion going benefits risk taking. The problem is, short-termism, though beneficial for today’s market activity, comes at a longer-term cost. Rising asset values in the near term are prompting asset allocators to reduce their long-term return assumptions. Asset class forecasts recently published by famed money manager Jeremy Grantham project large cap stocks underperforming inflation by more than three percentage points per year over the next seven years. His outlook for US bonds is equally unappealing. In the meantime, we plan to enjoy the trappings of today’s short-sighted policies, while tempering our enthusiasm for future returns. Cresset’s goals-based investing approach is predicated on offering our investors certainty in an uncertain market. This means that, despite the rhetoric, the data need to support our strategy. Our Lifestyle strategy strives to maximize income subject to a 95% success of a positive return over any three-year holding period. Our Growth strategy strives to maximize total return subject to a 90% success rate of a positive return over any seven-year holding period. Irrespective of policy babble and headlines, the numbers need to hold up.
The markets can no longer offer us our success rate for a seven-year holding period employing diversified public market equities. Blame a brew of elevated equity market valuations, volatility and heightened correlations. As a result, we have shifted a portion of our Growth allocation to a combination of private markets and private equity secondaries, where our expected returns are higher, and lower-beta equity strategies, which reduce volatility. Any market pullback that allow us to raise our future return expectations would enable us to redeploy our Growth assets back into public market equities.