Over the past 12 months, interest rates have increased at the fastest pace since the 1980s in both Australia and the United States (they’ve also risen dramatically in Europe and the United Kingdom). This has captivated the financial media, with a near-endless stream of articles about how this affects consumers’ cost of living, house prices, and other financial markets.

With the Reserve Bank of Australia (RBA) meeting on the first Tuesday of every month and the Federal Open Markets Committee (FOMC) meeting 8 times per year, there is always plenty to discuss about the next rate decision (or even the minutes of the previous session). Any decision that differs from “expectations” can have a dramatic impact on the stock market, or even currencies–as you can see from the drop in the Australian Dollar on Tuesday this week.

We saw this in June, when the RBA lifted the cash rate by 25 basis points (0.25%) to 4.1%. The majority of economists had predicted a “pause” and this had been “priced into markets.” In justifying the decision, RBA Governor Phillip Lowe referenced still-high inflation: “Inflation in Australia has passed its peak, but at 7 per cent is still too high and it will be some time yet before it is back in the target range.”

The FOMC, on the other hand, chose to take its first pause last week, with the Federal Funds Rate remaining at between 5.00% and 5.25%. This came as inflation had cooled in May to 4%, its lowest since April 2021 and less than half the peak of 9.1% this time last year. The FOMC left the door open for future increases however, depending on further reductions in the inflation rate towards the 2% target.

Interpreting the comments made by central bankers has become almost a sport for pundits and the financial media, including measures like overlaying transcripts of the meetings to look for discrepancies and requesting additional Q&A press conferences to further explain the decision-making process. The tone, body language, or any other possible indicators are used to see whether the future path of interest rates can be predicted. But does it all matter?

    Does obsessing over these monthly interest rate decisions actually matter to the extent the financial media would have you believe? A number of successful investors think not.

In his 2022 memo to clients What Really Matters, Howard Marks explores the factors that he believes are important to successful investing results. According to Marks, investors fail to predict macroeconomic events and have even less success predicting the market’s reaction to them. Even more importantly, investors find it nearly impossible to accurately predict both macroeconomic events and their outcomes on a consistent basis (even the world’s best economists fail to do this, which has led to the famous quote: “economists have predicted nine out of the last five recessions”).

Investors might get lucky once or twice, and this can often lead to fame in the financial media (Michael Burry has received a great deal of publicity for his success in shorting housing during the Global Financial Crisis, as portrayed in the film “The Big Short”). But there’s very little chance that an investor (no matter how intelligent or experienced) can successfully predict macroeconomic events and their outcomes on a regular basis.

Marks also wrote about the trading mentality that’s becoming perverse in today’s investing landscape. Investors have increasingly come to view stocks as a tool for generating short-term profits, rather than ownership in a business. This can be seen from the average holding period of individual stocks in the U.S., which is now just 10 months (!), down from 5 years back in the 1970s. Marks advocates that investors overcome this mindset and only buy shares in businesses they wish to own for the long-term.

 

This is the same as advice from investing juggernaut Warren Buffett, who once told CNBC “Nobody buys a farm based on whether they think it’s going to rain next year…they buy it because they think it’s going to be a good investment over the next 10 or 20 years”. Practising what he preaches, Buffett outlined the success of long-term holding Coca-Cola (which he has owned since 1988) in this year’s Berkshire Hathaway Letter to Shareholders.

Marks also wrote about volatility, pointing out the importance of being able to (emotionally) tolerate large market swings. This is again consistent with Buffett, who was once quoted as saying “We prefer a lumpy 15% return to a smooth 12% return.” By this Bufffett meant that he was focused on the end result (the investment’s total return) and not whether or how much it fluctuated along the way.

    It’s easy to get caught up in the market news of the day. It’s hard to avoid the headlines and the media is skilled at grabbing readers’ attention. Timeless investment principles provided by investors such as Marks and Buffett seem less immediate and less sexy, and there always seem reasons to ignore them in favour of the current macroeconomic developments. Yet just like eating vegetables and regular exercise, they are a proven method for generating long-term investing success.

Interest rates are a prime example. As Chris Mayer from Woodlock House points out in his most recent memo “The Wisdom of K”:

So, next time you find yourself reacting emotionally to the hot financial news of the day, perhaps turn your attention to a Howard Marks memo instead.

There is an old saying on Wall Street that “financial markets are driven by just two powerful emotions: Greed and Fear.” Investors often let their emotions dictate their decisions on when to buy, hold and sell investments, with fundamental value a distinct second consideration. This is rarely a recipe for success, and largely explains why investors vastly underperform even the indices they track. For example, over the two decades ending in 2020 the S&P 500 advanced 7.5% per year, yet the average investor gained only 2.9% per year as they zigged and zagged at precisely the wrong times. Being aware of behavioural biases and creating strategies to deal with these can dramatically improve an investor’s performance.

The problem with this is that the more investors are rewarded with higher share prices, the more risk they take on. They consider increasingly speculative companies with unproven business models and poor balance sheets, and often take on leverage to do so. They believe their past success is a reflection of things to come. But trend reversals can happen at any point, often without warning or an underlying “cause.” When trading is based purely on momentum with little regard to fundamental asset values, the downdraft can be significant, with a tidal wave of selling as investors desperately try to unload positions they held only because prices were rising.Rewind to the dot-com bubble and this is exactly how things played out, with a dramatic rise in share prices between 1995 and 2000–especially for any business remotely related to the Internet. Investors surged into the technology sector and the Nasdaq roared 400% higher in just five years, with very little attention paid to whether these companies generated any cash flow or had remotely viable business models. Once the furore was over and there were no more momentum buyers to be found, the trend suddenly reversed and share prices collapsed. It took the tech-heavy Nasdaq index 15 years to recover from the 2000 bear market, only returning to its former peak in 2015.

Fast forward to the Covid-19 pandemic era and it appears that history has rhymed. Lockdowns around the world caused investors to once again embrace the technology sector, replacing the dotcom darlings of AOL with Zoom Communications, whose share price roared five times higher as investors banked on the trend of remote work continuing. As a flashback, Amazon’s share price also doubled as the market bet that the heightened e-commerce demand would remain long after the pandemic. Once again these times were short-lived, with the share price of both companies falling more than 50% each as face-to-face interactions returned. Momentum investors who timed their exit poorly were left “holding the bag” and if history is any guide, it might be quite some time (if ever) before the share prices of these companies return to their pandemic highs.

This can lead to the very costly decision of choosing not to invest. And while it may feel less painful at the time, the lost gains can actually hurt far more over time. An extreme example is the performance of Magellan’s Hamish Douglass during the pandemic years. Prior to 2020, Douglass had made a name for himself, cementing his reputation as one of Australia’s most well known investors and amassing more than $100 billion of funds under management. But when the pandemic hit, Douglass made a decision that would cause significant underperformance and lose his status with investors. He sold a number of positions and increased his cash position dramatically, fearing the fallout from the pandemic would last for years. Instead, governments and central banks poured money into the economy, and the market rebound caught the Magellan fund off guard. While there’s no doubt this was a difficult set of outcomes to predict, the future is often cloudy and investors have typically been rewarded for buying great companies at steeply discounted prices in times of distress.

The other big reason is that you simply have a better investment idea from this point forward. You may have gained more confidence in another investment, it may have become cheaper, something in the industry may have changed the game. Whatever the cause, don’t resist switching one investment to another if it’s a much better idea. Warren Buffett is no stranger to this concept, highlighting in his 2023 Berkshire Hathaway letter to shareholders that most of his capital allocation decisions had been ‘no better than so-so’ , and that the results he’s renowned for were the product of a handful of a few ‘truly good decisions’. Investors often make the mistake of expecting a near perfect record, and are sorely disappointed when their results fall well short of these expectations. In reality, a six out of 10 strike rate will often more than get the job done.