Billionaires with Bad Advice (pt 1)

When someone makes it on the Forbes Billionaires list, people tend to take his or her thoughts on business seriously. This is even more the case when that same person became rich by owning a money management firm. Indeed, Forbes takes Kenneth Fisher’s view of the markets so seriously that it has made him its longest running columnist and commentator in its history. Forbes and certainly its readers should rethink the confidence they have placed in him.

Fisher’s latest commentary contains statements that are patently untrue and are likely to mislead investors in ways that will be quite damaging to their portfolios, so I have to respond.

Fisher regularly offers a free commentary to the investing public (“A suprising prediction by Kenneth Fisher”) which is used as a marketing tool for his asset management firm. (It is offered at no cost for answering a short questionnaire about how much money you have and how much 3rd party management interests you). His latest commentary attempts to explain why an investor who has his money with Fisher’s firm should continue to keep it there and fully invested, in spite of the dramatic losses such an investor has sustained following Fisher’s advice. He resorts to two basic claims arguing for remaining fully invested. One is simply false the other is questionable.

The first is a claim about how markets recover. The information implies that markets always recover over a reasonable amount of time and that the long term trend of the market is up. This is simply not true, as anyone who invested in Japan in 1989 can tell you. After the 1929 US market crash, the market took 25 years to regain its high, but at least it spent most of that stretch of 25 years well above the lows it made in 1932. What Japan suggests is that following a massive credit bubble, asset prices can keep falling indefinitely. 20 years after the Nikkei index peak, the market is still making new lows (prices are back to the same levels they were over 25 years ago). In fairness, the US has a few fundamental advantages that suggest that a true Japan scenario is unlikely. On the other hand, the US is also confronted with challenges Japanese firms did not have to deal with: Japan’s struggles to maintain output happened against a backdrop of robust global growth which supported profitable exports.

The key takeaway for the prudent investor is that counting on rising markets is dangerous. Big falls in asset prices do not guarantee that investments will produce satisfactory returns going forward. Lower prices do suggest higher earnings yields, provided that earnings mean-revert. Keynes had it right. “’We simply do not know” if earnings will return to previous trend growth. In Japan, they did not, which is why the market continues to languish more than 80% below its highs. Investors must be wary and continue to be selective in their investment choices as permanent loss of capital is still possible. The focus must be on “return of capital” more than on “return on capital”. They should keep a bias for “cash on the table” in the form of steady, well-protected dividends from firms that have non-cyclical earnings streams, coupled with solid balance sheets that could be financed from operating cash flow.