This line, made famous by the Bobby McFerrin song, is certainly evocative and, surprisingly, controversial. Some argue that it’s wishful thinking or worse, akin to burying one’s head in the sand. For us, at its core, the line implies that a positive attitude is necessary to cope with life’s adversities—a sentiment we happen to agree with. In the investment business too, an optimistic attitude is essential. Though worrying should also be part of the investment process, it can’t be allowed to overwhelm the overall process.
Worry Top Down, Invest Bottom Up
We can’t take credit for the concept of worrying about macro events yet investing based on micro analysis. But we do concur that most of one’s time should be spent in this mode. Meaning, markets are on the rise most of the time, climbing a proverbial wall of worry. Thus, it usually pays to be fully invested, relying on individual investment selections. However, prolonged bear markets do occur when recessions are causing earnings and valuations to deteriorate. And, if as a result of worrying, the impact of those drawdowns can be lessened, then it’s certainly worth the fretting.
Our biggest regret in the last few years is not being more fully invested, to participate to a greater degree along with the rising markets. Why was that the case? Mainly, for two reasons: first, we have been somewhat worried; and, second, it has been unusually difficult to find attractive opportunities in what has been a fully valued market.
Some live in a constant state of concern—doomers and gloomers. No way to live. Too much of a toll from elevated stress levels. It can also lead to inaction which, in the investment business, where one normally needs to be fully invested, is a poor course of action. We prefer to operate with a healthy dose of skepticism, wary of issues that might unduly impact our holdings and constantly watching our macro tools for alerts to a potential bear market.
Currently, there are quite a few things to be worried about. The political issues are downright depressing. The choices at the ballot boxes have been to select one’s least undesirable choice. And mismanagement abounds. Whether it’s federally, in the U.S. or Canada, or in most states and provinces, deficits are out of sight, at a time when they should be falling materially. Our leaders should be orchestrating budget surpluses in boom times. Globally, total debt relative to GDP is higher than at its peak in '07. The Bank of International Settlement is now showing total nonfinancial debt of around 245% of global GDP, up from 210% prior to the Great Recession. At these debt levels, the next recession could cause more dislocations than usual. 2
This impacts interest rates too. The rise in interest rates has been meaningful already. Prior to it pulling back to 2.8%, the 10-year U.S. Treasury had lifted to above 3% from about 2% last September. While demand at recent treasury auctions has been strong enough to meet the supply, we should be concerned with the higher cost of carry as deficits and interest rates rise simultaneously causing incremental ever-higher needs for government funding which could require even higher interest rates to attract bond investors. Higher interest rates could also be competitive for equity markets which are already fully valued and cause problems for many businesses and individuals whose finances are extended from debts taken on at attractively low rates. Subprime auto loans and student loans are particular areas of concern. As long as rates rise gradually, the impact ought to be more manageable, but clearly these debt levels should be a concern.
Inflation itself could also cause interest rates to keep rising. The central banks, fearing deflation, have focused on a 2%, or higher, inflation target. Now essentially achieved (the most recent PCE at 1.9%), there’s always a potential for it to overshoot. Especially with commodity prices rebounding, for example, oil prices whose significant rebound has contributed to much higher gasoline prices, propelling non-core inflationary pressures.