The Globe and Mail, Report on Business
Published March 4, 2011

By Tom Bradley

In addition to my day job, I sit on investment committees for two institutional funds, so every quarter there is a pile of manager reports to read and many different perspectives to assimilate. Unfortunately, if I try to do too much in a short time, as I did this week, my head starts to spin (wine is only partially responsible) and I develop a deep yearning to get back to basics. Just let me buy cheap stocks.

It’s the big-picture stuff that does me in. I’ve written in the past about my skepticism for top-down, economics-driven investing. Given the complexity of the world, and capital markets, it’s hard to consistently add value when there are so many conflicting factors feeding into every decision.

But despite my yearning, I recognize the need to find a balance between stock-picking and the big picture. Renowned value investor, Seth Klarman, described his approach to the conundrum as, “Worry top down. Invest bottom up.” At Steadyhand, we think similarly, although we describe it as trying to be “Approximately Right.”

Approximately Right means that most of the heavy lifting is done from the bottom up by our fund managers. In the context of a diversified portfolio, they do their best to buy securities that are worth considerably more than they’re trading for. As for the top down, most of the time we advise our clients to stick closely to their strategic asset mix, which is a guess (an educated guess, mind you) as to what combination of security types will work best in the long run.

This approach is boring, and has the appearance of doing nothing, but in the absence of compelling reasons to do otherwise, it’s also effective. As Warren Buffett says, “Wall Street makes its money on activity. You make your money on inactivity.”

Straying from the Long-Term Mix

But Approximately Right doesn’t mean standing idly by when there are extreme dislocations in the markets. To call on another of Mr. Buffett’s analogies, if there is a fat pitch over the middle of the plate, we will take the bat off our shoulder and swing. To be clear, I’m not suggesting that clients try to time the market based on headlines, but rather react to extremes in valuation and divergences from long-term trends. We want them to follow a steady course and get the market extremes approximately right as opposed to exactly wrong.

Are there reasons to stray from our long-term mix today? The answer is yes. Too many indicators are at extremes and most of them are either presaging slow economic growth or reflecting high valuations.

We have artificially low interest rates. Bonds prices are assuming a perfect scenario – an extended period of slow economic growth, benign inflation and some semblance of sound fiscal management by governments.

In the meantime, low rates are inflating asset prices. As one property manager said to me recently, it’s like adding rocket fuel to the real estate market. But it goes beyond buildings. Across a number of asset classes, we’re seeing too many bidding wars at a time when the economy is employment-challenged and in need of restraint.

The restraint part is the result of another biggie – government and consumer debt. Many countries, states, provinces and households have reached, or gone beyond, their credit limit. For the overextended, there is now little room for error.

There are other measures that are off trend. Corporate profit margins are running at all-time highs, which will make growth harder to come by. The world economy is more influenced than ever by countries lacking in stability, transparency and/or democracy. And the euphoria for gold and hostility for anything American (except Apple and Natalie Portman) are near all-time highs.

There’s always a reason for any one chart or statistic to be outside of its normal range, but when many of them need an explanation, it’s time to be wary. To me, that means lightening up on bonds, carrying extra cash and making sure my stock valuations are reasonable. It’s a sellers’ market now, but as the extremes come back to earth, as they invariably do, suppliers of capital (buyers) will regain the upper hand. It’s time to start getting the bat cocked.