I regularly write about fear & greed here. And I often worry about the tentative & fragile recovery we’re hoping for/seeing in the developed economies (led obviously by the US), and whether it’s built on a foundation of sand…or, more correctly, of printed money. I also worry about markets’ headline valuation ratios, which keep marching higher, and question if they’re priced to reflect a growth renaissance, or simply fool’s gold. And sometimes I talk just as much about preserving wealth, as I do about increasing wealth. Most of all, I incessantly interrogate the diversity & robustness of my portfolio, and cling to the comfort its deep value & special situation stocks offer – I demand they help me sleep soundly each night…
Lots of investors deal with this kind of free-floating market anxiety by keeping a healthy slug of cash in their portfolios – but my current cash allocation is actually minimal (& this isn’t a new phenomenon). Which starkly highlights an inherent contradiction of my portfolio:
If I worry so much, how come my entire portfolio’s invested in stocks..?!
Now, I could offer a prior argument – as I usually don’t consider cash a necessary component of a portfolio, with (low risk) event-driven investments generally serving as an acceptable & more attractive substitute. But that would just be a red herring, as I haven’t actually maintained a big allocation to such a cash alternative either. In reality, the answer’s much simpler…as I’ve often said (about management):
Watch what they do, not what they say!
Which is obviously an exhortation that can just as usefully be applied self-critically… OK yeah, I worry, so I obviously rationalise & anaesthetise these anxieties accordingly – but in reality, my fully-invested portfolio is a resounding confirmation of my past, present & continuing bullish stance on the markets. Hopefully, this doesn’t come as a surprise to you – despite the concerns I express regularly, I believe this bullishness has been a predominant & underlying theme of the blog all along.
[This Jul-2014 post is perhaps the best & most recent expression of my underlying bullishness – it just might be worth a read in its entirety].
And if you think I’m cheering a little late in the game, I reckon there are plenty more
innings goals to come… Which might seem odd – after all, the US market has more than tripled since its 2009 low, while headline index multiples around the globe are by no means cheap (and something like the US market’s CAPE ratio seems particularly alarming). But ask a broker, he’ll remind you: Despite the global rally to date, valuations certainly aren’t egregious, and factoring in the incipient/accelerating economic recovery we now see in the leading economies & the unprecedented low interest/inflation rate environment, they may even be(come) downright attractive.
Unfortunately, he won’t remind you of the inherent illogic of this overall proposition…accelerating economic growth (& increasing employment), an equity market that’s still attractively priced, low inflation, and near-zero (or even negative) interest rates, surely can’t go on happily co-existing together. In the end, either the bond market or the equity market has gotta win – I mean, they can’t both be right, now can they?!
Well, at least that’s what standard economic logic would dictate….
Um, except for the fact the current global economic environment isn’t remotely bog standard now, by any stretch of the imagination! EURIBOR’s just turned negative, trillions of sovereign bonds already sport negative yields, and even the benchmark 10-year Bund yield (despite doubling in the last few days!) could go sub-zero any time now. [By comparison, 10-year USTs offer a princely 1.98% – still a disturbingly low yield for an economy that’s supposed to clock up 2.5-3.0% real GDP growth in 2015]. Of course, this is preceded & accompanied by an equally unprecedented (in absolute & real terms) central bank experiment in monetary stimulus (with oodles of fiscal stimulus thrown in, for good measure) – the Fed alone has conjured up almost 4 trillion dollars out of thin air. Now, if all this funny money were ultimately withdrawn from the economy (in true Keynesian fashion), maybe it wouldn’t be so unprecedented – but we all know, without a shadow of a doubt, that’s never gonna happen…
Oddly enough, an alarming percentage of investors & commentators already seem to have shrugged their shoulders & resigned themselves to this new world as somehow being the new normal. To be cynical, that’s understandable – after all, this is a game the developed world’s been playing since the 1970s:
Robbing Peter to pay Paul…
First it was fiat currency inflation, then it was never-ending fiscal deficits, then it was out of control debt & entitlements, and then there’s the most dangerous idea of all – the notion markets (& consequently the entire financial system) must be saved, whatever the cost. [Which is actually a pretty new idea – governments & leaders traditionally focused on manipulating the key levers of the real economy, preferring to ignore what they viewed as a horribly unpredictable & uncontrollable stock market]. The Crash of ’87 was the real genesis of this new market intervention policy (interestingly, the ’80s were also notable for the level of official FX intervention), and the stakes have been ratcheting inexorably higher ever since with every new decade & crisis.
The fact we’ve seen no surge in QE-related (consumer price) inflation (despite some dire warnings at the time, I anticipated this back in 2012), has also been reassuring – though there’s precious little justification for this, as we continue to experience asset inflation instead. Politicians & central bankers have also seduced the populace with the usual paternalistic assurances that everything’s under control & advancing according to plan. Of course, this confidence is nothing more than sheer arrogance – if you consider the abysmal failure of the authorities to predict or prevent the 2008 financial crisis (& preceding crises), it’s sheer folly to assume they’ll be any more successful in foreseeing and controlling the ultimate (& probably unintended) consequences of QE. Most dangerous of all, central banks have delivered unprecedented global liquidity, naturally accompanied by a huge & ongoing compression in market volatility – which inevitably leads to over-confident & over-leveraged investors, who cannot help but sow the seeds of their own eventual destruction…
Frankly, I find this general complacency bewildering. Would it really be so strange, for example, to expect such an unparalleled monetary experiment might ultimately inflate the most incredible bubble we’ve ever seen? I certainly don’t think it’s any stranger than the presumption we’ve somehow ended up smack-dab on the precise glide-path to a perfect soft landing… And we can be sure one economic law still holds true:
There’s no such thing as a free lunch…
A painful lesson people have been forced to learn over & over throughout history – they inevitably end up paying more & more for their lunch (price inflation), or else the lunch bill only finally comes due once markets (& the economy) collapse due to speculative excess (asset inflation). Of course, we can all enjoy a good chuckle at their ignorance & naivete, yet somehow we can’t imagine people one day being equally amused at our own collective delusion – that a series of electronic book entries on a central bank computer is somehow any different than coin clipping. Because it’s not…
And now we’re obviously in uncharted territory – how can we be sure the basic laws of economics & finance still operate predictably in this new negative-bizarro world? We may as well be slumped in our chairs, peering at some giant bug-ridden spreadsheet & plugging in lots of negative numbers…and wondering what on earth it might spit out next?!
Maybe we’d all be better off admitting we haven’t a damn clue where we’re really going here, or where we’ll end up. But that’s not how we roll – we always need some kind of map to consult, even if we know we’re going to end up horribly lost… Now, I promise I’ll share my own road-map with you soon, but meanwhile I’ll defer (again) to the master – this is a pretty recent quote from Warren Buffett:
‘Everything is a function of interest rates. Interest rates are like gravity.’
Simple, instructive & profound – it isn’t one of his more famous quotes yet, but I suspect it may well become one. In just a handful of words, he manages to sum up where we are & where we’re heading. Consider the ramifications: It’s goodbye to the dull old world of business & finance. And welcome to the floating world – where there’s no gravity left to anchor us, and no price limit on our hopes & dreams…
In such a daring new world, how high do you think bubbles can float?!