By Julien B. Booth
February 11, 2020
Investing Rule 1: Preservation of Capital
Investing Rule 2: Do not forget Rule 1
We are becoming increasingly concerned that many investors have an under-appreciation for investment risk.
Financial assets have been inflating based upon Federal Reserve policy (more rate cuts) and Presidential Tweeting (seems like an oxymoron).
The Federal Reserve’s policy has been wonderful for us – lower risk, yielding assets get the first bid, but when we look at the foundation of demand (like commodities) and economic performance (GDP, earnings growth, etc.) the foundation appears more built on sand, than granite.
While ruminating this past weekend I made a quick list of indicators that give me pause. The takeaway: interest rates at 5000-year lows distorts ALL asset prices (except pure commodities).
Its artificial prosperity, and especially beneficial for those who own all the financial assets.
Commodity markets are driven by underlying demand, and speculation thereof. Oil, Copper, Agriculture (#BeanDeal) are telling a far different story than financial assets.
Oil and copper are plumbing multi-year lows.
Interest rate policy is the baseline (gravity) that all financial decisions are based. Taking rates to 0% makes just about any investment model out over time (assumptions are dangerous).
We have many an example of profit-less companies built on this sand: Uber, Lyft, Peloton, Beyond Meat, Marijuana stocks, and WeWork are just a few of the contemporary examples.
We prefer a defined path to profitability when taking investment risk.
At this juncture, 19% of the US stock market is 5 stocks (MSFT, AMZN, GOOG, APPL, BRK). In aggregate they trade at a multiple of earnings (32x range); a level we have not seen since the late 1990’s dot.com bubble. Junk bonds are at even more extreme valuations. When you look through to the other 2998 stocks the performance is severely lacking. Perhaps value is dead?
Is this time different? Not sure, but my 25 years experience in markets tells me otherwise.
We are quickly approaching the Greater Fool theory of investing – the expectations that prices will be higher tomorrow (just because).
Two recent events distilled the prevailing attitude for me:
1. A friend and colleague was describing a situation in his firm – the takeaway, they had increased allocations to stocks – because of TINA (There Is No Alternative).
2. Global Coronavirus Pandemic – if a sickness that affects over 400 Million people and the world’s largest resource consumption (see Copper and Oil above) does not bother financial markets what will?
Earnings once mattered…now that only seems to be liquidity (more Fed.).
We have a conscious bias to never permanently impairing (losing) our clients’ capital. When we see the behavior of late we take note.
Our job remains to prudently manage your funds. We take this role with utmost sincerity and wanted to communicate, in as plain of English as possible, our current concern.
Preservation of Capital is something we do not take lightly.
Thank you for letting us work for you.