Investing Uncertainty Got You Down? Here's How To Use It To Your Advantage

Published: March 22, 2017, 3:45 p.m.

b"With Vitaliy Katsenelson, Chief Investment Officer at Investment Management Associates and contributor to Institutional Investor Magazine
The Argument For Why\\xa0Investing Uncertainty\\xa0Is Actually A Good Thing
Vitaliy Katsenelson, CIO at Investment Management Associates in Denver, rejoins The Steve Pomeranz Show to talk with Steve about the importance of making \\u201cI don't know\\u201d a part of your investment strategy, and how familiarity with your portfolio holdings can make a big difference in terms of tolerating uncertainty. Referring to a recent article by Vitaliy on the subject of not knowing everything that might influence any given investment, Steve wonders whether saying \\u201cI don't know\\u201d would be professional suicide for an investment advisor. Vitaliy responds by reconstructing a case he's made for an \\u201cI don't know\\u201d kind of agnosticism about different possible scenarios that might affect portfolio planning. By way of example, he talks about an article he wrote in which he dedicates a page for arguing each side of a debate about whether inflation or deflation was likely to occur in the near future. He says he realized, based on strongly worded emails he received about the piece, that investors and other observers of the economy tended to strongly separate themselves into either inflationary or deflationary camps.
While offering a brief digression on how one might re-position one's investments for either inflation or deflation\\u2014adding gold for inflation or bonds for deflation, etc.\\u2014he says the deeper realization he reached is that either camp could be wrong, and there was no good way to be sure which would be more accurate. In any event, the cost of being wrong would be very costly. The end game is not to fatalistically say \\u201cforget it, it's impossible to know what will happen,\\u201d but rather to use not knowing as a jumping off point for a thought experiment whose goal is a portfolio adapted to complex circumstances. The best strategy for an \\u201cI don't know\\u201d world where either inflation or deflation is possible, Vitaliy reasoned, is to buy stocks that will maintain their value and hopefully their stock prices in either scenario. Vitaliy introduces the metaphor of the \\u201csecond best hand in poker\\u201d to describe investors so convinced that their outlooks are correct that they misjudge the strength of their hand and pay a big price for doing so.
Intrinsic Valuation vs. Short-term Stock Movements
Vitaliy distinguishes the inflationary/deflationary \\u201cI don't know\\u201d portfolio from typical portfolio diversification. In this case, it's about using a methodology to identify companies that can perform well in both inflationary and deflationary macro environments. Unpacking this methodology, he sketches the outlines of how his valuation process works. One important point he makes is that there can be a disconnect between a company's intrinsic value and its stock price, even with very well known, heavily traded companies. In fact, one of the goals of value investing is to find stocks that are \\u201cmispriced.\\u201d For buy and hold investors, this means priced too low. He remarks on the paradox that sometimes it's good for investors when solid companies suffer a stock price decline. The reason for this is that it allows companies to be more aggressive about buying back their own stock, and this bodes well for the financial strength of the company and eventually for its shareholders. He even views these \\u201ccorrections\\u201d in a stock price\\u2014if the underlying value of the company hasn't changed\\u2014as a buying opportunity for investors that have just taken the correction on the chin. This is a lesson he shares with his own clients, and he says that once absorbed, it can have a profound effect on their confidence in their portfolios. He adds that he considers it an important part of his job to \\u201cc..."