“The fox knows many things, but the hedgehog knows one big thing” Ancient Greek poet Archilochus
The hedgehog knows only one very important thing: when in danger it will curl up into a prickly ball to defy the cunning fox, who despite knowing an infinite variety of things, is defeated. The Oxford philosopher Isaiah Berlin (in his essay on Tolstoy in 1953[1]) divided up historical figures between hedgehogs and foxes: those who believed in a central unified philosophy in which all other things made sense (hedgehogs) and those who could not reconcile their observations of an infinite number of things into any unified wisdom (foxes). Whereas the hedgehog is self-confident to the point of dogma, the fox is a pluralist, self-critical and often evolving its views when faced with contrary evidence.
The analogy has also been used in assessing leadership styles, marketing and economic forecasting[2] but never to our knowledge applied to investors or investment styles: “hedgehogs” who see the market being driven by one all-powerful macro force that overwhelms stock specific rational; and “foxes”, fundamentalists who focus on individual security analysis, for whom a simple top-down view of the world is too simplistic.
The fox prides itself on being a stock-picker; on its diligent and time-consuming research, interviewing company management and peers, sifting through company reports and stock research. It believes that when stocks move in the opposite direction of that which it predicts, it is usually because its analysis of the company is faulty; most obviously in its estimate of the profits that the stock will earn. When the fox fails this leads to it redoubling its efforts to search for information or new facts about the company that it has missed, which has led it to make its apparently erroneous conclusions.
The hedgehog does not believe in meeting companies and is dismissive of the predictive power of backward-looking individual securities analysis. It points out that the idea of an efficient sell-side consensus on stock earnings is ever diminishing, given that analysts rarely move their numbers on evident shifts of macro in advance of company reports, unless guided to do so by management. As such market expectations of company earnings move way ahead of a stale consensus and the direct correlation between sell-side earnings revisions and share price movements is broken.
The market out-foxed the fox last year: 2018 was a bear market for stocks despite generally positive earnings delivery from companies. So far 2019 has resulted in positive returns from stocks, despite downward revisions to profits at most companies, in a manner which is reminiscent of 2016. In the last four calendar years, only one - 2017 - has seen stocks and earnings move in the same direction. This is problematic for foxes but not necessarily for hedgehogs.
The hedgehog is aware that most of the best years for stocks occur after a bear market and following a big injection of central bank liquidity. The hedgehog also believes in mean reversion: that those stocks that sold off most in the bear market will recover the most in the new market dynamic. No one rings a bell at the bottom of the market but popular shorts being squeezed is always a good signal. The hedgehog is also a firm believer in charts: it buys low on the chart for recovery potential.
The fox is uncomfortable buying stocks until the worst is over, not before they warn on profits and whilst management are still observing tough industry conditions with no visibility on recovery. The fox wants a portfolio which they can sleep comfortably with at night particularly given the losses recently occurred in cyclical stocks when their analysis (and the management of the companies in which they were invested) told them things were still going well. It was only after stocks started dropping that the first facts of slow-down became evident. The fox wondered whether its fund should be buying more “quant” data which might give it an “edge” in predicting the cycle turn. But then the fox found out from a friend at a “quant” shop that they didn’t see the downturn either.
The hedgehog believes in the old adage of buying cyclicals on high multiples and selling them on low multiples (but admits that this is no longer applicable since the sell-side is so slow in adjusting their numbers). Now this can be replaced by buying cyclicals when fundamentals are poor but not getting any worse and selling them when business is good and can’t get any better. This is how the hedgehog rolls.
The hedgehog is also dismissive of the idea of super-cycles, believing that we are stuck in a perpetual stop-go cycle in which central banks would like to remove monetary stimulus but can only do this when the global economy is strong and corporate profitability robust. The hedgehog wants to own risky assets like stocks only in periods where central banks are dovish. This means buying when the risks to growth are recognised by central banks and selling when there is widespread confidence in recovery. The hedgehog prides itself as a contrarian investor, although “trader” is a term he often prefers in hedgehog circles.
The fox doesn’t want to put any risk back on until companies report, believing that “fundamentals will reassert themselves” and stock prices will drop on bad news. The fox is also particularly concerned about Brexit and President Trump’s trade war with China. The fox wants these resolved before increasing his risk budget. He would also like to see leading economic indicators improve, after all they are supposed to be leading rather than lagging for a reason.
The hedgehog thinks policy makers now understand the need for compromise and that none want to be considered responsible for the great loss of wealth that would accompany a new recession or stock market crash. The hedgehog believes that President Trump’s infatuation with the “deal” means that one is inevitable to aid his re-election. Even if China, or Brexit, does not work out in a benign fashion, the hedgehog believes that this will simply be a better buying opportunity given that central bank liquidity will out-trump Trump and Brexit.
The fox prides himself on diversification of risk: its portfolio is a construction of multiple singular ideas, which in aggregate will offset the risk of being wrong on any individual stock. However, it has recently become concerned that its singular ideas do tend to have the same style risk: they are all based on the same static fundamental analysis and have a quality bias that chimes with the difficult economic times. The fox’s investment risk is diversified so long as the recent past can be extrapolated into the future. At the fox’s fund there is a consensus for quality companies, at least until things improve.
The hedgehog thinks hedges are now hogwash: with the market turn it is more concerned about bleeding away P+L with high beta shorts. But although the hedgehog wants the whole hog and not the hedge, perhaps it does have a warning for all foxes about markets and central bank liquidity?
Barry Norris
Argonaut Capital
February 2019
[1] http://berlin.wolf.ox.ac.uk/lists/onib/crowderrev.pdf
[2] https://www.economist.com/free-exchange/2009/02/18/better-a-fox-than-a-hedgehog)