Lessons in Investing from the Indy 500
May 24, 2016 | Your Finances
This weekend is the 100th running of the Indianapolis 500. Most of us will be watching to see who chugs milk in the victory lane. But there’s a lesson for investors on display as well.
The cars are fueled by E85; they have been since 2012. And that’s a cautionary tale for investors.
Why? In 2012, energy markets—most notably oil markets—were in a very different place. That May, the price of West Texas Intermediate crude oil resided in the mid $90s per barrel. Many investors, lulled into complacency after nearly a decade-long rise in prices and incessant chatter of peak oil (the theory that supply had peaked), believed that commodities and oil could only move in one direction–up.
Against this backdrop, I wrote an article arguing that capitalism would ride to the rescue of consumers. High oil prices had conspired to push traditional gas prices to $3.50 to $3.75 a gallon. Sensing an opportunity to profit by alleviating budget-strained drivers, business owners and entrepreneurs (think Tesla Motors) created substitute energy sources and methods to increase oil and gas supplies. As a result, alternative fuels like E85 began to take hold, and new technology (hydraulic fracturing, or “fracking”) was producing increased supplies of oil and natural gas.
However, oil prices and skepticism of the applicability of alternative fuels remained stubbornly high. But seeing E85 on display at the Indy 500 was proof that alternatives could be applied to commercial and consumer market segments in the near future. In fact, companies were already busy retrofitting fleets so they could be fueled by oil’s cheaper alternatives.
We all know what happened next. The price of oil eventually faltered, hitting a low in the upper $20s per barrel during January and February of 2016 before currently settling at nearly half the price it was in 2012. Investors who positioned their portfolios based on the belief that oil could only go higher are now likely regretting that decision.
The Past Informs the Future
It’s a cautionary tale about overall portfolio construction and the dangers of putting all your eggs in one basket or focusing on the latest hot trend. It seems like every few years we arrive at a place where investors are tempted to abandon their discipline and extrapolate absolute future certainties from recent trends.
The past is littered with examples of popular investment trends that drew investors in only to rob them of their wealth as the underlying fundamentals proved unsustainable. Who can forget the technology and health care bubble of the late 1990s? Or the more recent emerging-market/China glory days of the mid 2000s? In each circumstance, investors eventually succumbed to their better judgment and decided to chase past returns.
We appear to be at a point once again when investors, seemingly frustrated with the minimal returns of the past few years, are once again questioning the value of diversification and are vulnerable to chasing recent trends. For example, because U.S. markets have been performing so much better than international markets, investors are increasingly tempted to abandon international markets. Those who are now considering selling commodities are likely four years late to the game.
I’m not suggesting that you can’t or shouldn’t attempt to exploit opportunities or tilt your portfolio (an investment strategy that overweighs a particular investment style) to profit from your opinion. However, investors attempting to do this need a forward-looking process grounded in sound economic and portfolio construction principles. At a minimum this means you should avoid a rear-view-mirror analysis of what has worked in the recent past. Most importantly, it entails remaining true to the one philosophy that has served investors well for decades: portfolio diversification.
The Odds Are in Favor of Diversification
While I am no expert in picking the winners of the Indianapolis 500, I do know that if you allow me to select three drivers instead of one, my chance of success greatly increases. Investors looking for long-term success need to follow the same logic: Focus on singles and doubles rather than attempting to hit the homerun and striking out. For now sit back, enjoy the race and look for the update to this article in the year 2020.
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The opinions expressed are those of NMWMC as of the date stated on this material and are subject to change. This material does not constitute investment advice, is not intended as an endorsement of any specific investment or security and is not a prediction of what will happen in the markets. Information and opinions are derived from proprietary and non-proprietary sources, which may include Bloomberg, Morningstar, FactSet and Standard & Poor’s. Please remember that all investments carry some level of risk, including the potential loss of principal invested. No investment strategy can guarantee a profit or protect against loss.