I was early in 2004, but …
The Investment Perspective – January 2021
Peter Flannery CFP AFA
“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business”
2021, the closing risk…..is there opportunity ?
Hello 2021 and all it will bring. One potential risk stands out.
The closing risk
You may recall at the end of last year I alluded to the US Federal Reserve increasing their tolerance for a higher level of inflation. An indicator of rising interest rates.
Since then you could be forgiven for thinking that all interest rates have been doing anywhere is declining. However, if we look more closely at the 10-year bond rate in the US we can see that this rate has been steadily increasing.
The above chart tracks 10 year Treasuries showing the last 12 months
Recent data out of the US showed the monthly Consumer Price Index reading for December highlighting a rise of only 0.4% for the headline number which matched expectations.
Looking more closely, core CPI (excluding food and energy) edged up 0.1% which was also largely in line with a number of estimates. What this means is that there is limited traction for inflation in the immediate future with the pandemic worsening across America and of course, depressing demand in many segments within the US economy.
Simply, inflation remains “in the bottle” as it were for now, however let’s watch this space.
I mention it as you know, because interest rates generally determine asset prices. High interest rates generally mean low asset prices and low interest rates like we have at the moment mean unusually extended asset prices.
“You can’t tell….”
“You can’t tell who’s swimming naked until the tide goes out”
Rising interest rates is the closing pricing risk for, not only our direct share portfolios but also other assets as well. It applies to our own small business because higher interest rates mean that every day citizens around the world have a handbrake which is an increasing grab from interest rates on their weekly, fortnightly or monthly take-home pay. That can hurt. The impact can be widespread.
It would also impact on both residential and commercial property as those high yields (particularly for non-residential property) make the return from a cashflow perspective more difficult to achieve and in many cases, less.
All those (non-residential) property investments touting above bank rate yields when the tide was in, can suddenly become exposed as the tide rolls out.
In more serious conditions, some of these property companies are indeed swimming naked as they slow down or stop the once attractive yield. In more extreme cases they can also put a halt to any investor drawdowns of capital.
The worst case scenario is an inability to continue funding (the debt) and ultimately a collapse leaving investors out of pocket. Not likely all things equal but a possible scenario when the tide goes out far enough.
What about the share market!?
Although the timing is difficult to predict, inevitably there will come a point when the market suddenly decides that interest rates are at a level that it cannot sustain. That is because some investors will be highly leveraged and as interest rates increase they will need to reduce their debt servicing costs by selling down some (or a lot) of their holdings. There is also the real possibility that their banker suddenly becomes ‘risk off’ and demands repayment of the loan.
As you know, when there is less demand for something the price of it drops. That is the voting machine in full swing right there ( e.g. Tesla et al).
But what about your investment portfolio?
The cash up value of your investment portfolio will likely decline along with the market as the voting machine kicks into full gear.
The more academic among my clients will start thinking that maybe they should be scaling back, taking some profits and waiting for the volatility to erupt. The idea is that they can then go in and pick up some bargains once prices have dropped. It is a nice idea. It is a theory. It is even possible, but not probable.
My experience suggests we are much better off to stay with those good businesses in which we have invested.
In short, I advise against trying to time the markets. I also don’t advise rebalancing – I know … almost everyone says that is a very intelligent thing to do. It can be useful in some specific situations. Generally though, it serves to work against maximising compounding growth. Let me know if you want more detail.
Interest rates generally have a significant influence on asset prices and make the voting machine take action one way or another, sometimes unexpectedly and quite sharply. Rising interest rates at some point is the closing pricing risk that will affect asset values and trading prices.
For us, investing in the underlying business, we want to maintain and maximise our exposure to good businesses rather than rebalance (timing by another name) or play the share market.
That is because whilst you may get it right if you decide to time the markets (e.g. take profits) there is a high probability that you can get it wrong too.
Why take that chance when by sitting tight you sidestep that risk but will continue to maximise your returns anyway?
The opportunity for us relates specifically to:
- The value/eco-Investing methodology
- Investing in small caps where possible
- Investing in digital technology
It was not that long ago that nobody had heard of value investing. Now it seems everyone is an expert.
What I find intriguing is the varying iterations of what people think value investing means.
The most common is around buying assets cheap.
Partly right but not actually what value investing is about.
Specifically, if we follow the Warren Buffett and Charlie Munger approach, we know that it means investing in good businesses at a favourable price. This is something that is bandied about the market place regularly however, what any particular fund manager might mean when they use that phrase I suspect is quite different to what has been going on at Berkshire Hathaway for decades.
Here at WISEplanning as you may know, we tend to be evolutionary, changing and evolving as time rolls by.
The value investing methodology at WISEplanning from 10 to 15 years ago compared to today is very different.
Indeed it has morphed into eco-Investing which basically means investing in the economics of the underlying business.
It does not mean playing the share market or following share market tips, chasing fast rising prices or going with momentum investing as per share broking houses across the land.
eco-Investing is all about the ‘weighing machine’ (the economics of the business) and our discipline around that is what helps to maximise investment returns long-term.
Investing in small caps
This is horrible jargon that we probably use too frequently at WISEplanning – sorry. It just means investing in small businesses.
This is a more advanced approach. It is not for those with a Balanced or Growth Strategy.
It is more suitable for those with a Towards Advanced Growth or Advanced Growth Strategy. That is because small caps can be more risky, will see not only their share price but also their turnover and profit fluctuate, sometimes significantly.
That is okay though because even if we strike real trouble with one or two small caps, there will be others that offset any losses and indeed reward us well more with good returns over time. That is because small businesses that are good businesses can grow faster in the long run than larger businesses that have already been through that phase.
Investing in digital technology
This, could be called a fad. People chase fast rising prices (Tesla comes to mind – I like Elon Musk and Tesla BTW) which is based sometimes on lots of investing science and rationale which can have merit but just as often on the fear of missing out (FOMO) and a justification for this investing approach.
Technology based companies do have some advantages because electrons are physically very different to atoms.
Electrons weigh very little (all the electrons in the world weigh less than one Kiwifruit) do not require storage and shipping and help to reduce costs for businesses.
Atoms on the other hand can be heavy, need to be moved about and stored and therefore create a higher level of cost.
A number of technology type companies have enjoyed the first mover advantage and these are now well-known brand names (e.g. Google, Apple, Amazon….)
Let’s take advantage of the opportunity
There is opportunity with technology companies. A bit like small caps, it is more than just problematic locating those businesses that will be successful in the long run.
When you look at emerging technologies which we have seen over the last 200 years or more, we know that once we move through the initial flurry of new businesses popping up left, right and centre, inevitably many fall by the wayside. The trick is to invest in those that will last.
I mentioned in my Christmas message that this is an opportunity that we will look to take more advantage of moving forward by way of disruptor type businesses.
These are generally smaller businesses that may have an early mover advantage but for us at WISEplanning, they must also have sustainable and strengthening business economics before we will invest. We are investors – not speculators.
Let’s keep our feet on the ground
We do not invest in social media or newspaper headlines.
We do not chase rising prices and we look to avoid suffering from FOMO.
Successful investors tend to be focussed on their long-term goals. They maintain discipline around the methodology and take advantage of weak prices.
This is not ‘rocket science’. However for some, it is surprisingly difficult to do!
“Educated and academic does not always equal rational.”