Secrets Of Success: Keep the past to confirm the present

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The Independent Online

Like me, I dare say that you find the vast daily outpouring of information and views from high-quality sources we all can access is both a blessing and a curse - so much information to process and not enough time to pick the wheat from the chaff.

This, in turn, only feeds the natural tendency we all have as investors to place far too much emphasis on new information at the expense of old - a flaw that psychologists have shown is one of the fundamental reasons why we end up making bad decisions. It also stops us seeing the big trend changes in asset class performance that, as noted here last week, will, in practice, make the biggest difference to our future wealth.

I cannot resist passing on the findings of a recent psychological study in which two sets of people, one with brain damage and one without, were asked to take a simple wealth-maximising test. The former group, whose emotional responses were apparently inhibited by their condition, performed appreciably better in the test, underlining how important emotional stability is in decision-making.

But the counter-benefit of the internet is the chance it also offers us to keep a permanent library at our finger tips, assuming we can archive the good stuff in a systematic way. The trick here, it seems to me, is to try to keep interesting and thought-provoking material that points to possible turning points and trend shifts ahead of time, and then reference back to it at periodic intervals to see if reality is confirming the hypothesis or not.

By way of an example, I can refer you to an archived article on the bond market that can currently be found on the home page of the website of Grant's Interest Rate Observer (www.grants This is a well-regarded New York publication whose editor, Jim Grant, has been following developments in the credit markets with a jaundiced eye for many years. It is one of a handful of publications which are read (or at least seen) by almost every serious investor I know.

The article in question, Bonds - The New Generation, looks back over the history of the bond markets and speculates that we recently passed the bottom of one of the big cyclical turning points in the history of interest rates.

These turning points, as Grant points out, come at long-distance intervals, as long cycles in the bond markets are typically measured in waves of 20 to 30 years or longer. The big turning points in the last century were 1920, 1946 and 1981, and, he thinks, there was another in 2003, when US 10-year-bond yields briefly fell to 3.1 per cent, a level they have not repeated since. (But the 30-year bond yield has recently threatened to break through its previous lows.)

Few participants in the markets are aware of these turning points at the time, and, indeed, the older and more experienced you are, the harder it is to accept that they have happened.

Like old generals, who are said to be always fighting the last war, professional investors find it just as hard to accept that what they have come to regard as iron rules of thumb may not hold into the future.

When the dividend yield on stocks fell below that of bonds for the first time in the late 1950s, for example, many investors took years to accept that this was a permanent, rather than a temporary, change.

The article is well worth reading, not because it is necessarily right (though at the moment, its warning that bond yields are set to enter a new, long-wave period in which market interest rates are set to rise steadily is starting to look prescient), but because the issue of where bond markets are going next is one of the central strategic issues investors have to consider.

Get that wrong and you are likely to pay a high price during the next 10 to 20 years, as it will impinge on almost every aspect of an individual's financial health. Grant's article was written in June 2004, but is just as valid today as when it was written.

The alternative view to Grant's, held for example by the independent financial adviser David Kauders, is that the disinflationary forces that have helped to drive down interest rates so strongly during the past 20 years are still not spent, and that we are, if anything, heading towards a period of deflation, rather than renewed concerns about inflation. If that scenario is right, bond yields could well go lower still and might surprise everyone by going down to levels not seen since the end of the Second World War.

How will we know which school of thought is right? The answer is that we will never know for sure in advance. The important thing is to keep track of the evidence (charts are very useful for this) and be prepared to shift ground as the case gets either stronger or weaker. It has to be said that Grant, by his own admission, is a terrible short-term predictor of where markets will go, but my own hunch is that he is the more likely to be on the right track in the longer term. Time will tell.

n n n A footnote to my piece last week about Grantham Mayo, Van Otterloo's website, and the firm's views on the importance of mean reversion. Jeremy Grantham, the founder of the firm, thinks we may be seeing, in the current behaviour of the oil price, a rare exception to the normal rules. There could be, he says, a paradigm shift going on in which the price of oil moves to a higher plane that persists for some time, echoing the moves that took place in the 1970s (when the price quadrupled) and 1986 (when it fell to a new, much lower equilibrium level).

Having spent a good part of my career writing about the oil business, I am sure he is right. The laws of supply and demand do work in the oil business - but only eventually.

In the short term, which in the oil business means five to 10 years, there are all sorts of frictions that ensure it takes time for new sources of supply to be brought onstream in response to higher prices, while consumers quickly forget the need to be frugal in their use.

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