“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
Compounding Returns
What is compounding when we refer to investing? Compounding is the process in which an asset's earnings, from either capital gains or interest, are reinvested to generate additional earnings over time.
Whenever I talk with people of a certain vintage about money principles or some financial advice, they only have one thing inside their brain — that is how to get rich quickly? People need to understand that investing takes time. It requires focus (savings) and a handle on emotions to build a successful outcome - but panic and impatience can destroy those results as well. As Warren Buffett rightly said: “Investing is like growing grass or watching paint dry”.
Morgan Housel (his book, Psychology of Money, I highly recommend) added on Twitter - “Compounding is hard because a bad three months is more memorable than an incredible three years.”
Albert Einstein famously said — “Compound interest is the eighth wonder of the world. He who understands it earns it; he who doesn’t pay it.”
Simple interest is the interest that is paid only to the initial principal balance. Compound interest, basically, is what is paid on the initial principal balance plus the accumulated interest from prior periods.
In other words, compound interest is the interest paid on the interest, and then it is again paid on the interest on both of the previously collective interest and this cycle/chain goes on and on. That’s why time is the most powerful aspect of compounding. As of May 2022, Warren Buffett’s net worth was $116 billion. Of that, $84.2 billion was accumulated after his 50th birthday. $81.5 billion came after he qualified for Social Security, in his mid-60s. The real key to his success is that he’s been a phenomenal investor for three-quarters of a century. Had he started investing in his 30s and retired in his 60s, few people would have ever heard of him. Buffett began serious investing when he was 10 years old. By the time he was 30 he had a net worth of $1 million, or $9.3 million adjusted for inflation and he’s been able to generate this with an annual average return of 22%. That’s why he is a phenomenal investor. His results came from compounding but his secret is time. A 22% annual return pales in comparison to some other investors that you have never heard of and have a net worth far less than Warren because they were at it for a couple less decades.
Long term time horizons are why seemingly reasonable numbers become so impressive over time. I sold a house in 2014 for $600 000 and the original owners paid $75 000 for it in 1977. $75k to $600k in 37 years sounds mind blowing but really it is just 4.5% per year. To me, 4.5% annually is a not an overwhelming number. Yet, compounding over 37 years leads to great results. Not that it matters for this illustration but that house was only worth $600k because $200k or more was put into it over 37 years to keep it well maintained and updated.
U.S. Recession Scorecard
Our U.S. recession scorecard went from all green in the not too distant past…to one yellow and then to this. ISM manufacturing is not a giant surprise. My takeaway is that manufacturers ordered more than they figured they would get and then received it all. The good news is they got what they wanted the bad news is that it front loaded 2022 and orders are reduced from here.
The market seems to be a good predictor in that it prices in bad news before it happens. And then rebounds well before any good news makes it to the headlines. That is why getting out now and getting back in when things are better is a strategy doomed to fail. It sounds great on paper but doesn’t seem to work in the real world. Many investors still try, however.
Most metrics show this market to be oversold. Earnings have been surprisingly resilient in the wake of recent developments. This is in contrast to the behaviour earlier in the year when there appeared to be a greater degree of trepidation. Why is this? First, central banks are already aggressively tackling inflation, with a series of forceful rate hikes in recent months. Second, there are signs that suggest future inflation may be poised to decline. For example, commodity prices have fallen substantially, which will eventually make its way into future inflation readings. Financial conditions have tightened meaningfully in a short period of time and are starting to deliver some of the intended impact, namely a deceleration in demand. Lastly, and perhaps most importantly, measures of longer-term future inflation expectations have come down, and in some cases meaningfully. All this suggests that while inflation remains a serious issue at the present time, it may pose less of a challenge in the future.
I hope you enjoy a nice weekend and look forward to catching up soon,
J. Todd Kennedy, CIM, FCSI
Senior Portfolio Manager
613-566-4582