What do the subprime mortgage crisis in the US, the Arab spring, the Occupy movement, the Turkish protests, the Internet, and social media have to do with the investment decision-making process? More than you might suspect.
We live in an age where virtually everyone is connected and has access to the global network to share their experiences, views, opinions, etc. As a result, any one group can light a match that generates a spark that gets transmitted throughout the global community with the potential to alter the status quo. And all this can happen at a rate of speed unprecedented in the history of the world. Accordingly, such power can - and often does - result in change, sometimes in a highly disruptive manner. However, traditional investors using traditional tools have a dual problem with all this.
To begin, it doesn't compute. That is to say the ability to quantify a high speed transmission event into a discounted cash flow model using the traditional methodology does not exist. And considering the fact that it is not the job of a traditional investor to reconfigure the valuation models conceived decades ago, why would or could such an individual or organization make such an alteration? Then there is issue of monitoring and measuring the high speed transmission event. Boots on the ground and kicking the tires of something that is often ephemeral but is, from time to time, highly significant are simply not part of the capabilities of the traditional investor toolbox. Which brings us to the second problem, bottom-up analytics and investing.
Many traditional investors are bottom-up oriented. Company specific investing. Warren Buffett is the living and breathing model of this approach. Yet, can such an approach factor in broader, more macro thematic issues into a financial and then valuation model of, say, a US domestic railroad company? The answer is quite clearly no. Yet, in a changed global economic and financial markets environment, such factors have occurred with increased frequency over the past several decades. (Fat tails, anyone?) Perhaps, this explains in part the underperformance of Berkshire since the US stock market low of March 2009 (see accompanying chart*).
Investment Strategy Implications
The economic and financial markets' landscape has changed. It's not your grandfather's economy or stock market anymore. The social networking aspect of all this has been the latest development as an enabler of this high speed interconnectedness. And while the investment implications may not be apparent, they are real. Forces festering beneath the surface can erupt with remarkable force and speed potentially rendering what is to what was.
This means that risk and reward are amped up and should be accounted for by investors in their valuation models. It may be hard to quantify but it is a reality that can be best accounted for through an adjustment in the risk input to the valuation models used. The alternative - the ostrich approach - is hardly the prudent way to go.
*click image to enlarge
Thematic Thursdays is a product of Blue Marble Research Advisory and focuses on important global trends and themes impacting the global economy and markets and an integral part of the three-legged stool approach of Blue Marble Research.
On average, thematic issues are longer term in nature, transcending the business cycle in time and economic sector categorizations. However, many shorter term players in the financial markets use trends and themes as a staple of their investment strategy. Understanding how to incorporate thematic analysis - along with fundamental and technical analyses - is an integral part of the process that forms the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.
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