“Investing is simple, but not easy,” goes the famous Warren Buffett quote – a lovely, concise way of stating an old truth. But not much these days seems simple or easy. In investing and the world at large, enduring beliefs have been getting tested.
Eric wrote on page 2 about why the stock market could be soaring when the economy is so awful – and the cognitive dissidence has been jarring. One thing that’s become clear is that the stock market is not the economy we see in our neighborhoods. Restaurants and stores on our streets may be closing, but they are not the stock market. Big companies are the stock market — and above all, the market is Apple, Amazon, Microsoft, Google, and Facebook. Whether you cheer this on or think it’s crazy, it is the reality — for now.
But the truly big reality to face up to today is how the Fed’s extraordinary actions have upended the way all markets work. The Fed has done a lot to drive interest rates to near zero, and the implications are huge – for stocks, bonds, and everything from gold to housing. Bonds simply won’t return much under these conditions, but stocks will soar. Most favored will be growth stocks – the ones that don’t earn much now but are expected to earn a lot more in the future, however distant that may be. Money made in the future suddenly looks more valuable at zero interest rates because there’s no longer much to the idea that a dollar today is worth more than a dollar tomorrow.
The question is, what do you do? How do you find your way when the Fed rules, and Microsoft and Amazon seem to run everything else?
For a start, I suggest acknowledging that this is a world where fundamentals and valuation don’t count for as much as they used to. That doesn’t mean we’re abandoning our heritage in fundamental valuation — we’re not. And it’s not saying this will last forever – it won’t. But if you look back at the last few months, you have to say it was better to follow the Fed than the fundamentals.
So let’s not be stubborn. This is a time to be nimble. We are not in a world where normal interest rates are 5% or where we can choose from 7300 publicly traded stocks, as there were in 1996 (versus under 3700 today). Nor is this a world where small companies have as good a shot as they once did at out-competing giants (those were the days!). This is a world focused on what the Fed does — and where the search for value has shifted away from discounted cash flow analysis toward ideas about what thrives after COVID.
That’s okay though, because things always are changing – and that’s a very good thing to remember. The “Don’t fight the Fed” card has been working so far, but it’s not clear the Fed can or will keep this up forever. In fact, perhaps the most important thing investors can do now is think about what will happen if the Fed can’t or won’t. In addition, I’d say it’s well worth preparing today for the possibility of inflation tomorrow. We can’t know the future, but thinking about stores of value outside the traditional stock/bond mix seems wise to me.
In sum: Embrace the current reality (the Fed + COVID) and don’t be stubborn. But don’t abandon the principles that moor you (fundamental valuation). Understand that low rates could be here a long time, but also be prepared for when they aren’t (inflation?). And finally, I will add, Diversify! With so many unknowns, it’s probably not the best time to try to be a hero. Spread your bets – perhaps a lot of quality at good prices, a few underdogs, and a sprinkling of pricier growth if it makes sense.
And that may be the way to think about those big tech stocks. The Amazon’s and Microsoft’s are a real conundrum. On the one hand, there are a lot of good fundamental reasons to believe in them. Their returns are real and so are their growth prospects. But on the other, nothing lasts forever, and it never looks good when everyone crowds into the same things – that is, if like me, you hope to avoid crowded exits. But look at your choices here, as investment blogger Ben Carlson has suggested: You can jump into these stocks all the way and hope things keep going up forever (unlikely). You can stubbornly stay on the sidelines (and stay grouchy). Or you can own a little bit in a diversified portfolio. Which makes sense to you?
