Efficiency is a cornerstone of marathon success, as it is for your investments and financial plans. One of the first things we learn in Geometry is that the shortest distance between two points is a straight line;it’s the most efficient path from one to the other. Yet, I’m continually amazed during races by runners who never deviate from their self-assigned traffic lanes and seem to ignore potential roadblocks that could lead to less-efficient racing.
Average investors can get locked into similarly inefficient behaviors when they, in behavioral finance terms,adopt a Belief Preservation. This is defined as the reluctance to search for evidence that contradicts beliefs, treating contrary beliefs with skepticism when presented, and avoiding changes to their beliefs even when the evidence presented demonstrates flaws in their investment strategies.
Sometimes the road ahead isn’t clearly visible and it’s tough to see themost efficient path. We then look for negative indications so that we can position ourselves to avoid traps like getting caught by the herd. These observations lead to actions that will help us in the long run such as backing off the pace, surging ahead, or stopping to rehydrate.
Similarly, when managing an investment portfolio, it is important to be on the alert for indications of changes in the road ahead. Here are some key indicators of the current state of the economy:
• Jobs in the United States continue along a traditional recovery path, having recovered about three fourths of the jobs lost in the recession of 2008. We are still a long way from full employment,and without full employment, inflation is unlikely in the next few years.
• The current expansion has lots of room to continue, as the most important cyclical sectors, automobiles and housing are just now returning to their long run averages. But the past five years of below average sales, plus the continued growth of the population, has created a huge pent-up demand in both sectors.
• Most importantly, we expect stronger growth in the US, with the first quarter estimate around 3% based on numbers already being reported. Europe continues to struggle with a recession, while most of the emerging markets appear quite solid.
Some of the most important indicatorswe’re watching include the FED’s unprecedented balance sheet and the militant “hot spots” around the world. Sequestration is a political issue with minimal impact on the overall economy, but will cause serious disruptions in placeslike Ridgecrest California which are completely dependent on Department of Defense research spending.
We’re continually looking at stock market valuations, which have changed considerably during the recent market surge, as an indicator of the investment risks in the road ahead.Valuations are measured against a multitude of norms, and most US measures indicate the US stock market is fairly priced. It’s not overvalued, but most of the abnormal opportunity has been realized. In short, we believe that there is room for continued gains and that we’ve returned to a relatively “normal” market environment.