Powell’s Upbeat Testimony

Fed Chairman Jerome Powell delivered the first semi-annual testimony on Capitol Hill last Wednesday, and the market paid close attention to his remarks on interest rates.

Powell’s comments leaned towards optimism but cited the continued strength of the labour market and the overall economy as having bought the Fed time to ensure inflation is under control and moving towards its target of 2% before lowering rates.

Powell acknowledged the delicate balance the Fed faces, with the risk of easing interest rates too soon leading to a resurgence in inflation and necessitating more restrictive policies, while waiting too long could strain the economy unnecessarily despite limited signs of strain thus far.

Mixed Labour Market Report

The Bureau of Labor Statistics released February’s nonfarm payroll report on Friday, revealing the addition of 275,000 jobs during the month, surpassing economists’ expectations of 200,000. However, the initial job reports for December 2023 and January 2024 were significantly revised downward, suggesting the labour market is not that strong. Unemployment also rose to 3.9% from 3.7% in January, marking the first increase in over four months, while wage growth slowed.

What The Data Means

Individuals, businesses, and the stock market benefit from lower interest rates as the cost of borrowing decreases, and the responsibility falls on the Fed to determine when this will happen.

While the market responded positively to Powell’s optimistic remarks on Wednesday, Friday’s mixed labour report suggests that the Fed may want to wait longer than the market would like before lowering rates. Consequently, economists are now pricing in the likelihood of the first-rate cut when the Fed convenes in June, with over 70% confidence.

Other News

Broadcom’s (AVGO) first quarter (Q1) 2024 earnings missed analyst’s expectations on Thursday evening, sending its value -7% lower on Friday and dragging the entire sector with it, including the mighty Nvidia (NVDA), which lost -5.6% of its value on Friday.

Meanwhile, gold prices surged to an all-time high last week, presumably due to strong demand from central banks. Turkey remains the largest buyer of gold amid its ongoing struggle with inflation, which soared to 67% in February.

Gold is widely regarded as a safe haven for capital, and the trend of central banks accumulating gold reserves suggests a cautious outlook on the current global economic landscape.

1. February Consumer Price Index (CPI)

• When: Tuesday, 12 March 2023

• Where: Bureau of Labor Statistics

• Why it Matters: CPI is a key measure of inflation. Expectations are that CPI will increase by 0.43% compared to January 2024, and anything higher will be interpreted negatively by the market.

2. February Produce Price Index (PPI)

• When: Thursday, 14 March 2023

• Where: Bureau of Labor Statistics

• Why it Matters: PPI is another measure of inflation, and economists want to see inflation trending downward.

Where I Would Invest My Money

I am often asked by individuals how they should invest their money. Whether it is a lump sum they want to invest or a recurring contribution, say monthly or annually, they want to grow over the long term.

The answer is simple: I would,

Invest in an S&P 500 index tracking fund with the lowest fees possible

And with that, my job is done. Thank you, and good night! 😉

Jokes aside, let’s dig into why…

What is an index tracking fund?

An index tracking fund is a portfolio designed to mimic the makeup and performance of an index. Constructed correctly, the fund will match the performance of the index it mirrors.

An S&P 500 index tracking fund tracks the S&P 500, an index of the 500 largest U.S. listed companies. As the S&P 500 moves each day, so will the returns of that fund.

Why an index tracking fund?

Returns

We know from Lockstep’s research that the S&P 500 has returned an average of 11% per year for the last 50 years. That is a pretty attractive return, especially in USD, and while there is no guarantee, we will hopefully earn a similar rate of return going forward.

Obviously, growth will not be in a straight line, and there will be some bad years, but there will also be some great years. So, by investing a lump sum today or in regular intervals for the next 10 - 20 years, or even longer, we should expect that money to compound at roughly 11% per year, provided it is invested for the long term.

Low Fees

One of the biggest obstacles for individual investors is the fees charged by asset managers, which can add up quickly. For example:

Let’s say you invest $100,000 with a top-performing manager, and they generate a 15% return, or $15,000, in a year. But they charge a 2% management fee and a 20% performance fee.

From the start, you owe them 2% of your $100,000, equating to $2,000 regardless if the fund is up or down. Because the fund appreciated this year, you also owe them 20% of the $15,000 they earned for you, or $3,000.

Therefore, of the $15,000 earned, you only get back $10,000 after fees, meaning your actual return is 10%, not 15%!

Of course, that is an extreme example, and great money managers charge a lot less, but the point is that fees erode your earnings. On the other hand, index funds generally have very low fees, some with as low as 0.02% per year.

Money Managers Don’t Beat The Market

According to S&P Global’s SPIVA scorecard, 60% of active fund managers underperformed the S&P 500 in 2023. However, those that beat the index in 2023 are not guaranteed to outperform it next year. In fact, only 12% have outperformed in the previous 15 years.

So, while it is possible to beat the market, the odds are stacked against the professionals, so it is far better to be the market by investing in an index fund.

How to invest in an Index Tracking Fund?

The easiest way to invest in an index tracking fund is to buy an exchange-traded fund (ETF). An ETF is a security that trades similarly to an individual stock on the stock exchange, so it is as simple as buying it in the open market whenever you want and holding it for as long as you can.

What Index Tracking ETF should I buy?

There are so many to choose from, but below is a list of the top 3 most well-known:

If it is the best way to invest, why don’t I do it?

By now, the question on your mind is, “If this is the best way to invest, why don’t I do it?”

The short answer - I am a stubborn fool!

The long answer is - As with professional money managers, I believe I can beat the market by picking stocks that will outperform the index over the long term. I’m fully aware that the odds are stacked against me.

BUT

I love investing!

I am passionate about learning about new industries and companies and how their business models work. I love looking for these companies and being involved in the stock market.

I also believe the odds are better tipped in my favour than professional money managers for the following reasons:

• Size – The size of a fund limits investment opportunities such that the bigger the fund - the fewer opportunities. I don’t have this problem. I can invest in any company regardless of size.

• Agility – Mandates often limit managers’ ability to maximise the advantages of waiting for the best opportunities to present themselves.

• Duration – Pressure to perform can make professional money managers more short-term focused.

Conclusion

While I am stubborn enough to believe I will do better than the market in the long term, if I had any other job and couldn’t dedicate myself 100% to investing and the research it requires, I would buy an index tracking fund and hold it for as long as possible. And whenever I had any excess cash, I would buy more of that index.

It’s as simple as that!

By the way, I am not the only one who thinks this…

For those unfamiliar with Charlie Munger, the man credited by Warren Buffett as the architect of Berkshire Hathaway, was not only a legendary investor but also renowned for his decision-making capabilities. His philosophy, encapsulated in Tren Griffin’s book “Charlie Munger: The Complete Investor” provides valuable insights into Munger’s investment strategies and his mental model framework.

Charlie Munger & Mental Models

Mental models are internal frameworks that we use to understand the world and are core to our decision-making process. Our experiences, beliefs, values, culture, and education shape these mental models.

Consider a practical scenario involving three individuals from diverse backgrounds—a doctor, an engineer, and an accountant—each tasked with analysing a business facing declining sales:

• Drawing from medical training, the doctor diagnoses the problem akin to a patient’s symptoms, seeking remedies.

• The engineer might scrutinise the business’s systems and processes, focusing on production, supply chain, and infrastructure.

• Meanwhile, the accountant will likely delve into the financial aspects, examining revenue streams, cost structures, and margins.

In the example above, you are likely to favour one approach over another, but it is critical to realise that this is precisely Munger’s point!

Munger believed that expanding one’s mental models enables a more comprehensive assessment of decisions, leading to better outcomes. If we want to be great decision-makers, we need to approach decisions from the doctors’, engineers’, and accountants’ perspectives.

Dedication to Continuous Learning

Munger’s approach implies that anyone, regardless of background or education, can become a successful investor simply by committing to continuous learning. The wider we branch out, the more angles we can approach each decision from, and according to Charlie, the more angles we can view a decision from, the better the outcome will be.

In Summary

Charlie Munger’s mental model framework encourages us to broaden our perspectives, incorporate diverse viewpoints, and commit to lifelong learning. By doing so, we can better navigate complex situations and make better decisions, which in turn makes us better investors.

Here is your chance to ask those questions on your mind or share your insights with the Lockstep community.

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