THE NEW GOLD RUSH
Welcome to the new gold rush. There is a feeling in the investment world that we are in an Age of Disruption that is going to change the way we do everything. From a stock investor standpoint, therefore, companies are either disruptor or disruptees. If you are among the former, you are going to own the future and therefore, the narrative goes, no stock price is theoretically too high. If you are among the latter, the amount of money you’re making (or more likely losing) today doesn’t matter. The market seems to believe that in the future you won’t exist so why bother estimating your last few years of cash flow when the disruptors are just SO MUCH more interesting. This certainly feels reminiscent of 1999 to me. What makes today different however, is that the market believes the Fed has learned its lesson this time. We know that the Fed popped the dot.com bubble in March 2000 after it began removing the excess liquidity it had flooded the economy with leading up to Y2K. The current market narrative absolutely believes that the Powell Fed is not going to make that mistake; it will inject reserves in a crisis and it will never take them back out.
Seriously, though, there is a mindset right now that sees stocks as being almost invulnerable due to low interest rates, spectacularly friendly central banks, and the continuing decline in the supply of stock shares. In other words, the internals are so positive that it will take an external shock to cause a bear market. The Wuhan coronavirus was thought to present that kind of threat, but the market now seems to believe otherwise. Back in late 2018 the U.S.-China trade war similarly spooked investors. Today, it is hard to see that market pullback as anything other than a buying opportunity because for the past ten years, it’s been exactly that. Taken even more broadly, it seems the market believes that every external threat is a buying opportunity – because, in recent history, that’s what it’s been.
(And even as I wrote last paragraph I was thinking: “This is when bull markets end. When everybody is convinced that it can’t be stopped.”)
MINNEAPOLIS CFA SOCIETY DINNER NOTES
I had the good fortune of being at the CFA Society annual dinner last Thursday night. The keynote speaker was Rick Rieder, head of Fixed Income at Blackrock and consultant to the Federal Reserve Bank of New York. The following are some of his insights I think you might find useful:
- Interest rates are going to stay low for a very, very long time due to demographics (aging global populations), the excess of demand for bonds over supply of bonds, technological innovation (nobody can raise prices without inviting disruption), and the inherent stability of a service economy versus a manufacturing economy.
- Financial conditions are too easy. The Fed will not lower rates in 2020.
- Bonds are a terrible place to put money if one is seeking risk adjusted return. Bonds yield vary little and do not provide nearly enough compensation for the risks they present. They aren’t even good as “ballast” against a stock market decline (again, because rates are so low). One would be much better off using out-of-the-money options or being long volatility, both of which are underpriced, versus using overvalued bonds to hedge against a pullback in stocks.
- Today the consensus view is arrived at much quicker than in the past; in days, not weeks or months, so we all get “correctly” positioned in a very short time. A meaningful change to the accepted current wisdom could be very dangerous, for the sheer volume of money that would attempt to move out of very crowded trades.
- Illiquidity is priced way too high. In the past investors were paid a premium to lock up money. Today there is so much demand for returns that don’t have to be marked-to-market daily that private markets are probably MORE expensive than public ones.
- Price-earnings ratios are not a good measure of stock valuation. A better way is to measure free cash flow adjusted for financing costs (which today are very low). Looked at this way, stocks are not expensive. They are a much better bet than bonds.
- The valuations of innovative companies are going to keep rising relative to the valuation of those that don’t or can’t. There is no business cycle in the conventional sense anymore, so waiting for the late cycle move in inflation that boosts late cyclicals and other value stocks at the expense of growth and interest rate sensitive stocks is not going to pay off anytime soon.
A FEW MORE THOUGHTS
The next morning (Friday the 14th) I listened to an interesting conference call with Bill Eigen of JPMorgan (their head of Opportunistic Fixed income). He said almost the exact same things as Rick Rieder did the night before. Many Bond pros really don’t like bonds right now. They prefer stocks from a risk-reward standpoint. As Eigen pointed out, bonds are basically math. You know exactly what you are going to get. Under most scenarios at this point, the expected future total return you’ll earn is too low to compensate for the risks you are taking.
The energy sector may be worth a look right now. Energy stocks have underperformed for years, and most sit at, or near, decade lows. The catalyst to a move higher may be the realization that fracked wells have a much shorter lifespan than regular wells. Energy producers are fracking in the easy and obvious places now, and those wells are being quickly depleted. Meanwhile, those companies are reinvesting the proceeds into more new production. At some point supply could fall below demand again as energy companies realize that maximizing production capacity may not the best way to build shareholder value.
Another interesting industry is utilities. Fund managers love to talk about how they don’t own any utilities since they are highly regulated slow growing companies trading close to record high valuations. And yet they keep going up in price. Why? The low cost of leverage and the popularity of low volatility investing. Also, as our society moves toward an increasingly wired society, it uses more power, as would the widespread acceptance of electric vehicles.
Through last Friday, gold bullion ETFs (IAU, GLD, etc.) were up approximately 3.8% for the year.[i] Oddly enough, gold mining ETFs and funds were down -1% to -4%.[ii] It is hard not to think that bullion is just a better instability hedge than mining stocks (which to some extent are going to reflect liquidity conditions in the economy). That said, be careful of the tax consequences of owning bullion ETFs in taxable accounts. They may make a better investment for tax deferred accounts.
-Mark Carlton, CFA
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[i] Per Telemet Orion
[ii] Per Telemet Orion as measured by GOAU, GDX, SGGDX, and OPSGX