The Cry of the Loonie
When our currency is devalued, our purchasing power is eroded and many of us are uncomfortable with the implications. Last week it was reported that a head of cauliflower was selling for $7.00 in Ottawa and Toronto. Travelling out of the country is costing 30% more than it did only 18 months ago. Bottled water is costing more per litre than refined oil. On the flip side, it costs more for the oil barrel than the oil that is in it and the price we pay at the pump is . . . well not nearly as low as we would like it to be.
Even though this form of inflation is tough enough already, some people will make matters worse, like moths flying into an open flame. One of my favorite people, Charlie Munger, once said, “All I want to know is where I’m going to die, so I can avoid going there.” Here is where you want to avoid.
Making important decisions in the absence of facts and certainty can be brutal, especially when we don’t know that we don’t know. At least if we know we don’t know we can protect ourselves. Better yet, we can limit our decision making to the things we know with a high degree of certainty. Picking up a knife after it has fallen to the floor comes to mind, rather than trying to catch it as it is falling through the air.
Many people are scarcely able to stop making predictions about things they can’t possibly know – currency movements for example. Rather than simply excepting something as unknowable, people make predictions or educated guesses, often leading to the impression that we can know or understand what we don’t know. It’s a comfort to have an answer for everything and it leads to false precision.
The delusion of understanding something that is inherently unpredictable is a perfect trap, even for the most intelligent among us. Keep in mind, if intelligence was an indicator of great success at investing, the richest people in the world would be librarians and stand-up comedians. This common propensity to replace uncertainty with the illusion of understanding is a great destroyer of wealth. Understanding a circle of competence and staying within that circle is simple, not easy.
Asking questions is a good idea, especially when circumstances change. A sharply devalued currency is certainly worth considering as an investor. Here is what we know with a high degree of certainty.
When we invest here at home, currency is neutral; we can expect to earn the aggregate of what our businesses earn. Our purchasing power with the loonie is exactly the same as our purchasing power with a business investment made here in Canada. On the other hand, when we purchase a business for investment outside of Canada, our currency is converted into the currency of the foreign country where we are investing. We can expect to earn the aggregate of what our foreign businesses earn, plus or minus the change in the value of the loonie, compared to the currency of the country where we are investing.
To be clear about this, if the loonie falls relative to the value of the US dollar and we’ve invested in US businesses, we’ve insulated ourselves from the devalued loonie. We could have zero earnings on our US businesses and the currency difference from a devalued loonie is still likely to deliver positive results. Currency can move quickly and let’s face it – earning 6% from business operations takes a lot more effort than catching 6% from a falling loonie. Those pennies from heaven may be as simple as catching a falling knife!
Other investors prefer to eliminate the fortuitous risk of currency and rely solely on good homework and understanding the intrinsic value of the underlying businesses to determine gains and losses. Hedging strategies neutralize the negative and positive effects of currency. There is usually a cost associated with the “insurance” of hedging and over the long term the averages will return a neutral value for currency, so some investors prefer to simply let the currency ride.
Now let’s look at what we know that we don’t know. Predicting currency movements goes into the “too hard pile”. We don’t know what will happen next with a high degree of certainty, so we can either hedge the risk to neutralize the effect, let the long term averages play out, or try to catch the falling knife. Making important decisions using information that is unreliable is about as effective as talking sense to a drunkard, so we choose to focus on the underlying businesses. Some of our managers in foreign equities hedge currency, and some go long and leave it alone.
We also don’t know how much more prices will fall. Fear will create opportunities and our behavior is to be greedy when others are fearful. The cash hoarded by our lead equity fund manager, Larry Sarbit, was over 40% of the Sarbit US Equity fund for much of the past couple of years. Our performance suffered with a soaring US market and the weight of cash acting as an anchor and a free hedge. We usually have the last laugh. Our big cash “problem” is finding a home in the beautiful businesses that are being discarded and the worse it gets, the better we get.
Those who bought things they wanted with money they didn’t have are now selling things they need to get money they want. During moments of uncertainty those with the clarity to focus on what they know can step forward and buy quality when others are selling at a discount.
false precision | circle of competance | purchasing power | intrinsic value | hedging | Loonie | too hard pile | currency | devaluation | oil | certainty | falling knife | predictions | Charlie Munger | delusion