Tuesday, June 25, 2013

Siegel, Clearly Simple Wealth Approach

Tall Feng Shui style photo of dark rounded rock over white backgroundKeep it Simple, Stupid  isn't the same as Keep it Stupid Simple. Both are KISS principles; yet they send different messages.
The former implies being less than brilliant, to say the least. This is the message that most intellectuals deliver to their audience. Their discourses often create a sense of awe for their genius while leaving a gaping understanding-void behind. They seem to thrive from dishing unbreakable magic.
On the other hand, the latter KISS, which is less common but the more adequate alternative, accentuates the need for simplicity. This is what Professor Jeremy Siegel does while also being master of the stock universe at prestigious Wharton School of Business. The confident, succinct, transparent, charismatic and perpetually optimistic professor has written a book that just leaves you feeling good, despite all the noise and fear roaming the nation right now. The Future for Investors demystifies the drivers for success behind the work of great money makers like Oracle of Omaha, Warren Buffett. No seƱor, not even a doctorate degree from no less than MIT gets in the way of professor Siegel's ability to clearly explain to average people.
Evidently, to think in terms of either growth or value investing is wrong. Based on Siegel's extensive research, one should evaluate market expectations through the lens of market pricing. Is the market expecting high asset value growth and has therefore pushed asset prices higher? A yes, suggests looking elsewhere.
Composition photo of financial markets giant Jeremy Siegel next to his new book "The Future for Investors"
The Future for Investors at Amazon
Next, scavenge among assets with lower growth expectation for those with solid cash flows. Any asset with high capital investment requirements should be put to the side until cash is no longer being siphoned. Previous studies have debunked the myth that higher capital investing is essential to lead the industry. This also puts tremendous pressure on the idea that gold, a non cash-flowing asset, could deliver more than mere parity with inflation.
Something I found very interesting within the subject of cash flows is the suggestion that the investor and no one else should determine how to re-deploy corporate profits or dividends. Letting management "invest" the money leads to poor results in the aggregate due to low capital investment returns. Then there is the fact that letting government decide how to invest is even worse. Government often spends several times more to create a job than the job pays. Handing cash would be a much more effective way to use money. But who wants to hand out cash without resulting in value add.
Photo of fifteen one hundred dollar bills arranged in ascending house-looking structures
Real Estate Investments
Only the reinvestment of cash flows through the purchase of additional shares leads to substantial market out-performance; especially during recessionary times. Now, this explains why Buffet acquired insurance and consumer staples businesses. These companies deliver great and sustainable cash flows that can be reinvested into more cash flowing assets. And I thought that staying away from fast growing businesses was a cute way for a conservative old man like Buffet to invest. He has really misrepresented his approach. The goal is not to seek businesses that a simple Cornhusker could understand. No, the goal is to buy as much cash flow as possible with every penny so that more cash flows could be acquired next. The math behind the compounding properties of this method is very robust. To think that Mr. Buffet would support higher taxes, a way for citizens to invest in the country, while he clearly lets no one decide how to invest his dividends makes me feel betrayed by the Oracle. Sadly, this feeling has now surfaced twice. I previously wrote once about it in my Secret double-life - Warren Buffet spices things up with leverage post.
That's it. Low expectations and high reinvestable cash flows. As the Geico commercial would read, "So easy a caveman can do it".
Professor Siegel also proposed a great thesis for how the negative impact from the upcoming demography shift will be counterbalanced by global growth. Soon Baby-boomers will start selling their accumulated assets to pay for retirement. Siegel feels that the massive wealth and consumption expansion taking place across the developing world will help sustain present asset prices. But I am not so sure about it.
Photo image of modern Chinese metropolis in full bloom
There are three factors that in my mind could impede his scenario from taking place. Deficiency, timing and risk profile could make his calculations unrealistic. First, all markets are deficient. Whether there is a 10% or a 90% deficiency in the transfer function needed to match boomer assets for sale with growing demand elsewhere is presently unknown. Have you ever needed to sell something yet failed fining the buyer who would pay your price? Yes, it happens all of the time. After you sell at less than you wished, you will inevitably find someone who would had paid more. Why was it so difficult to find the buyer when you needed it? Because all markets have a deficiency factor which could range from very low to very high. We don't know how efficient each relevant market will be over the next 30 years. What we know is that even a highly efficient market will offer enough friction to call for a review of the math used.
Second, timing means that citizens in developing economies could be willing to buy Boomer assets years after the sale took place. That would be disastrous for sellers even when buyers largely outnumber them.
Third and presently evident is risk profile. Equity prices have resiliently gone up because of market distortions created by the Fed. Risk-adverse buyers are having to shorten their time horizon to compensate for the higher risk associated with the assets they are now buying; assets like dividend paying stocks and residential properties for rent. Any change in economic risk will probably force assets out of their uncommitted hands.
Photo of two Baby Boomers over a Volkswagen van in the 60's
I am not sure that developing consumers will be ready to buy the same type of risk assets as Boomers did. Boomers grew up in a very different economic environment. Their parents experienced great wealth growth; which gave them the opportunity to party la Vida Loca while question every rule and standard. Boomers display a sense of invincibility and entitlement missing from any other large group. Instead, developing nation citizens would surely behave like members of the Greatest Generation, those that fought in WWII and built the industrial nation that we now know. Global growth citizens will probably be financially conservative and hard working. So, I doubt that they will have the same risk appetite than Boomers. If their savings are redeployed by money managers into riskier asset classes, then we risk discouraging these savers while also creating great market volatility and rampant crashes; a scenario that is probably closer to the truth. I would love to see if professor Siegel has accounted for the three concerns I am raising here.
Professor Siegel's book is fantastic. His delivery is as welcomed through his writing as when he talks to the CNBC cameras. Thank you professor for your hard work and commitment to a better future for investors.

Book Title: The Future for Investors
Book Subtitle: Why the Tried and the True Triumph Over the Bold and the New
Author: Jeremy J. Siegel
Publisher: Crown Publishing Group
ISBN: 140008198X

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