Quarterly Commentary

October 8, 2018

To the friends and clients of the Harvey Investment Company:

The U.S. stock markets rose sharply in the third quarter of 2018 with the S&P 500 market index rising 7.71%. For the year the S&P 500 is up 10.56% and extends a striking ascent that began in 2012. In these past six and three quarter years, stocks have advanced more than 150% – an annual compound growth rate of 15.4%. Remember, a pool of assets growing at 15% doubles in five years; needless to say we are on quite a roll.

How to explain the welcome run? Rear view mirrors are never foggy, so we can cite a host of factors – low interest rates, weak foreign markets making ours more desirable, deep corporate tax cuts propelling company earnings, and a well-balanced economy. Unfortunately the clarity of the rear view never extends to the front windshield. What’s up ahead is anything but clear. To understand the myriad factors that make economic forecasts so tenuous, we refer the ambitious reader to an article that appeared in the September 30th, Sunday New York Times business section titled “The Invisible Recession of 2016.” The premise of the article rings quite true to us. It lays out complex forces that came together to create a real depression in several sectors of the U.S. economy in the 2015-16 time frame. Subsequent recovery in these areas explains the longevity of the current business expansion, but its influence is largely invisible to the public at large.

In 2005, David Romer, a prominent Cal-Berkley economist and member of the National Bureau of Economic Research published a study titled “Do Firms Maximize? Evidence from Pro Football.” After studying more than 700 games, Romer concluded that in many fourth-down situations, teams are better off going for it than opting for a punt or field goal. Romer identified 1,068 fourth down situations where, statistically speaking, the right call would have been to go for it. The NFL teams punted or kicked a field goal 959 of those situations. Put another way, the coaches made the suboptimal choice nearly 90% of the time. Why was it so hard for these coaches to go for it on fourth-down? Was it job security? Were they concerned about looking stupid? Were they simply too busy to question conventional wisdom?

New England Patriots coach Bill Belichick, regarded by many as the smartest coach in football, has defied conventional wisdom and gone for it on fourth down more often than any of his colleagues. In his first head coaching job with the Cleveland Browns, he went for it on fourth down about one out of nine times. His timidity at Cleveland carried over to his next job in New England. That is until his team won three Super Bowls in his first five years. Since then Belichick is almost three times as likely to go for it as when he was in Cleveland. What changed? No doubt his heightened sense of job security gave him the confidence to do the smart thing even if it occasionally made him look dumb. But perhaps there is more to it than that.

We would posit that his confidence in his own instincts had risen from decades of painstaking preparation. After graduating with a degree in economics from Wesleyan University, Belichick accepted a $25 per week position as a glorified gopher for the Baltimore Colts. Over the next ten years he coached special teams, tight ends, linebackers, and wide receivers for three other NFL teams. His work ethic became legendary. He devoured game film, preparing for each opponent as if it were a Super Bowl. What some coaches saw as boring details, Belichick saw as an advantage. Don’t sweat the small stuff? That wasn’t Belichick’s philosophy. One opportunity could change a game and Belichick wanted to recognize it when he saw it.

Belichick’s growth continued when he became defensive coordinator of the New York Giants under head coach Bill Parcells. With the Giants, he learned the game wasn’t just X’s and O’s. He had to manage his players. “We never went into a game that we weren’t mentally prepared for while Bill was coach,” said Hall of Fame linebacker Lawrence Taylor. Belichick’s work ethic was contagious. His players felt like they had an edge. He convinced them they were playing chess while everyone else was playing checkers. Belichick became known as “Doom” because he trained his players to consider the bad outcomes of every play. The games were easy for the players because Belichick had already taken them through every scenario in practice. Why is it so easy for Belichick to go for it on fourth-down? It’s just another play in a lifetime of plays. He’s paid his dues.

This isn’t a sports column, so what does this have to do with investing? Yogi Berra famously said, “In theory there is no difference between theory and practice. In practice there is.” It was easy for the economist we cited to theorize that football coaches should defy conventional wisdom. It’s tougher to do in practice. It’s not enough to be different; you also have to be right. You quickly learn in investing that you aren’t just competing against the market averages, you’re competing against other people, and the competition is fiercer than any NFL game. Everyone is smart. Everyone works hard. How does an investor separate from the pack? One way is consistency of effort. A football game often comes down to a few plays. Similarly, it only takes a few investment opportunities to separate a great record from a good one. The problem is one never knows when those opportunities will come, so you’re always watching, waiting.

There is nothing glamorous about investment research. It’s tedious, hard detail work. The job is equivalent to low-order detective tasks – finding sources of information, looking for clues, trying to figure out what’s going on. You have to simultaneously understand the companies – their products, financials, management, industry structure and then decide if their market price accurately reflects their true value and future prospects. There is no magic formula. There are no shortcuts. It’s laborious, grinding work and not everyone wants to do it. We do.

We appreciate your support and belief in our program.

Samuel Harvey
Samuel C. Harvey

We are pleased to offer you upon request and without charge a copy of Part 2A of our Form ADV. This disclosure document contains information about the business practices and procedures of Harvey Investment Company, LLC. Please call us at (502) 339-8270, if you would like a copy.