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2nd Quarter 2019 CIO Commentary

Are You Nervous Yet?

The world can be a scary place, even for investors. While we may not be on the front lines protesting the proposed extradition law in Hong Kong or in the Straits of Hormuz defending supertankers filled with oil against attack, these serious situations can cause great injury to investment portfolios, including ours. So, at least for us, the answer is yes, we are nervous. We struggle to assess geopolitical issues about which we have limited insight and even less control. These episodes tend to spring up and take center stage quickly, with a concomitant impact on financial markets. Typically, then, our job is to “read and react,” which means something different to every investor. For those investors whose amygdala[1] is in charge, the tendency is to sell now and watch things unfold while waiting in cash. Many humans are wired this way. The modern-day economic answer to the evolutionary survival question “fight or flight” is often to sell on bad news.

Without getting into too much psychobabble, we note that behavioral economics suggests that selling on bad news may not be the correct response. For those of you who have closely tracked TIFF’s behavior over the last several years, you may have noticed that we tend to sit tight in situations like those described above, resisting the natural urge to sell. More to the point, we often prepare ourselves to buy should any meaningful pricing weakness appear following episodic bad news. Baron Rothschild famously said, “The time to buy is when there’s blood in the streets.” Maybe a little more cheerily, Warren Buffet reminds investors to “be fearful when others are greedy and greedy when others are fearful.” Both maxims suggest that ignoring your amygdala is generally a good idea.

So, are we currently becoming more aggressive and increasing stock weightings in our comprehensive portfolios? No. The implication that accompanies both the Rothschild and Buffet quotations is that asset prices have declined appreciably, and by most measures today, they have not. The S&P 500, for example, is near its all-time high as we write. Not much fear there. The forward price/earnings multiple on the S&P 500 is about 16x. Not high, but not low either. Similarly, the MSCI All County World Index is just shy of its peak, and the price/earnings ratio is about 14x. There are markets that have pulled back further, with MSCI China about 15% below its peak with a 10x forward price/earnings multiple, and those that recently set new highs, as MSCI Australia did after gaining roughly 20% year to date. The interesting thing about the China and Australia dichotomy is that much of what drives resource-rich Australia is Chinese economic growth.

Looking inside the US markets, we note that the leader of the most powerful financial institution in the world has learned well how important his words are. Yes, we mean Chairman Powell of the Federal Reserve Board, who, after stating in December that the Fed would not raise interest rates for nine months, is now signaling a rate cut at any time to counter the impending effects of US tariffs on China and other nations. Markets seem quite confident that a rate cut will happen at the Fed’s July meeting. This Fed willingness to act to offset economic drags is certainly supportive of equity markets. On the other hand, investor uncertainty caused by the tariff merry-go-round is likely to keep equity prices contained, at least for a while. We continue to think the US and China will eventually find a compromise that is at least acceptable for both and leads to continued global growth.

We’ll end this set of observations by reminding everyone that most good endowments and foundations react to changing capital market environments by rebalancing their portfolios toward some sort of long-term target asset allocation, often called the “policy portfolio.” A policy portfolio, re-visited periodically, is intended to represent a strategic allocation that should enable the institution to achieve its long-term return objectives. Basic human wiring tempts many investors to try to time the market, often causing purchases or sales that, with the benefit of hindsight, are undertaken at inopportune times. Following a disciplined plan to rebalance into weakness is much harder, but it is also usually more rewarding.

[1] The amygdala is a set of neurons located deep in the brain’s medial temporal lobe that play a key role in processing emotion.

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