The Two Ms

Yesterday, Monica and I did a "dry run" for our late summer camping trip. In the photo, you can see the result of my campfire skills. Physically, I get tired these days so exercise is limited to easy trail walking.

Over on Alternative Perspectives, Clas shares his experiences from Epic Camp over the years. Coming up he will explain "How to run a 2:42 marathon off the bike" -- we'll get that live in a few weeks. It is an entertaining read.

I've been reading Ayn Rand -- (GV, I'll mail the book back soon). Ms. Rand is a fine writer and gets me excited about living up to my maximum potential. Her encouragement to reduce theory to basic truths interested me in relation to endurance sports -- I'll continue to think about that because I sense that with some effort it would be possible to create a straightforward model for endurance training. I've tried to do that with my Four Pillars article but there could be a clearer theory waiting out there.

In the meantime, as the summer winds down and the cyber surfing season heats up... two things kept coming back to be as I flipped the pages.

Equality -- the need to place personal responsibility for individual action as a high priority. This is even more important for those that seek to lead, or influence, others in the field of individual rights.

Intellectual Domination -- I watch media pundits (and cyber celebrities) claim to be guardians of the truth while engaging in satire and bullying. Their actions cloaked in humor and/or intellectual superiority while seeking to subdue any discussion that runs counter to their ideas. Spending one's talent bullying the students (we once were) strikes me as the path of a wasted life. There is a higher way available to us.

++++

So, I'm back in Colorado following a few meetings in New York. In the Big Apple, I was fortunate to be able to stay with my Everest climbing, hedgefund’ing, Ironman’ing buddy, Greg "the kid" Vadasdi.

It is always fun to spend time with “The Kid”. Similar to my buddy, Ed McDevitt (I’m on to you, amigo), Greg is one of those intelligent guys that enhances his success by having the world underestimate him. I’m going to start working on that in 2008. Life can be easier when our competition under-rate us.

I received some follow-up on my piece on international financial markets. A few people asked what I thought was going to happen in various markets.

I have no clue!

Be suspicious of people that claim to have a clue!

When it comes to forecasting my experience is that it is totally impossible to predict short-term movements. We have no idea and the more certain the experts become, the greater the opportunity for an unexpected event to really shake things up.

My formal financial education is getting a touch dated (Class of ’90). At McGill, I was reasonably well schooled in the traditional drivers of markets as well as the technical theories that have been purported to drive financial markets. My academic and technical background is useful for reading the FT, or Wall Street Journal, but it doesn’t serve me well when I try to comprehend what I actually see in the world around me. In fact, it is probably a liability.

If you’ve been reading my stuff for the last couple of years then you will have seen my interest in learning from authors that immerse themselves in how things actually work (be they markets or people). The GordoWorld team is in the process of updating my website and one of the additions will be a section on my recommended reading list. Mat and I will trawl through my library and type-up what I liked, and why.

Fundamental analysis works well for estimating the likely long term path of an asset or investment opportunity. However, it falls short when asked to explain what actually happens in the short term. In other words, my academic (and real-world) training are useful for valuation but something else seems to drive pricing.

What is it?

For me, the two main drivers are:

(a) Mood; and

(b) Money.

Let’s take money first. How many people have the ability to purchase the asset, or make the investment? Most people will spend to the maximum limit of their ability to pay. As an aside, always find out your client’s budget before bidding on a project.

If we enhance ability to pay with low cost finance and easily obtained credit lines then you’ll bump up the demand for assets and, in most people, reduce price sensitivity. Many corporations (and CEOs) follow a similar path -- it very difficult for spending and investment decisions to be made free of the influence of capital available.

There is limited transparency on the true position of global liquidity – however, the careful observer can make educated guesses on the impact of global shocks on capital markets. Our recent experience with the credit contraction that followed the sub-prime shock is an example.

With mood I consider:

How do “I” feel about the opportunity?

How do people around me feel about the opportunity?

How does the broader public feel about the opportunity?

While I think that I’m an optimist when it comes to life, my conservative nature means that I’m a nervous seller. Where I’ve made mistakes on pricing is when I failed to take into account differences between my perception and the broader public. I’ve consistently sold early in my deals.

Interestingly, this tendency hasn’t cost me many investment opportunities. I’ve always had more deals available than personal appetite to fund them. In fact, our property development company started because we had a mismatch between good deals and available capital.

Why is it important to track these factors? It’s important because a change in either one can be a leading indicator of an approaching valuation swing. When these two factors change direction in tandem then we are going to see a shift in asset pricing.

So when people ask me what’s going to happen… I have to say that I have no idea. As an investor, what I look for is situations where my best guess is that my entry pricing is less than fundamental valuation. That creates the opportunity – reality is then dictated by the hard work of an ethical management team.

Investing is about: (a) solid fundamental analysis; (b) limiting the cost of your mistakes; (c) paying less than fundamental value at the front-end; (d) avoiding fraud; and (e) backing the efforts of outstanding people. Of these factors, the two deadly sins of Private Equity are overpaying and backing crooks -- very tough to recover from either of these. If your deal doesn't fit these parameters then you are speculating, rather than investing.

In terms of market timing, don’t expect to get that perfectly right other than by fluke. Watch for shifts in the two Ms. When a trend is established, consider the likelihood that this direction will be sustained. Invest only when you see a gap between price and valuation.

It sounds so easy. Reality is tougher but the basics will serve us well for as long as we temper our greedy instincts.

Stick with your winners; sell them only when concentration fears start to keep you up at night. Historically, that’s been my early warning system on both people and deals – if I’m thinking about you at midnight then we’ll probably be speaking shortly!

Always hold a portion of your portfolio in high quality cash equivalents – this will enable you to capitalize on unexpected opportunities and assist with the (near impossible) task of staying calm when everyone else is losing their cool. By definition, your best deals will be offered to you when everyone else is out of cash. As much as possible, be countercyclical in your fundraising and capital reserves.

Waiting and watching…

gordo

PS -- I'm off to Santa Cruz next week to see Brant and Mark. After that Monica and I will be camping for two weeks. I've set things up so that I should be able to keep publishing.