Ave, Ave, Ave Janet.
And so it came to pass that investors saw a bright star in the East…directly over the Marriner S Eccles Building, at the corner of 20th street and Constitution Avenue in Washington, DC, home of the Federal Reserve.
‘What comes after me goes before me,’ said Janet Yellen, so confusing investors that they bid up the Dow over the 18,000 mark… a new milestone and a new record.
It is the season of miracles. Investors are convinced that Ms Yellen can perform a trick worthy of Jesus Himself. It was He that multiplied the loaves and the fishes…made the blind see and the lame walk…and turned water into wine.
It is She who creates real wealth out of nothing. At least, that is what the common folk believe (and the wise men too…). For it was neither something solid nor important that made stocks more valuable last week; it was something gassy and impossible. It is the idea that real wealth can be conjured up…like a rabbit out of a hat…by the magicians at the Fed.
Federal Reserve Policy is the opiate of the people, the cynics will say. Maybe so. They may not understand its mysteries, but they like it. After all, it promises wealth without work…or saving…or self-discipline…or investment. The wealth just comes, by the grace of Janet Yellen and her fellow Fed governors.
Last week, it came in abundance.
‘Hallelujah,’ said equity investors.
Ms Yellen let it be known that she would be patient about letting interest go whither they wouldst. She’s got them right where she wants them and she intends to hold them there until she’s sure the lean years are over…or until Kingdom Come…whichever comes first.
We are convinced that holding interest rates down does indeed increase the likelihood of a bubbly stock market. But we are damned if we can understand how twisting interest rate arms makes businesses more valuable. Is near as we can make out, it merely puts their shoulders out of joint.
This is an age of wonders. Anything is possible.
But let us get our feet back on the ground…let us return to our series on investing.
We were discussing value investing. Here, we repeat ourselves, because this is important, and because we can’t think of anything new to say. A stock is a share of a business. The value is determined by figuring out how much it will earn in the years ahead, and then adjusting the number to present value (a bird in the hand is worth two in the bush)…and then some (leaving yourself a ‘margin of error’ in case something goes wrong).
If you do this correctly, diligently, and patiently you will not necessarily make more money than other investors but you will deserve to make more money. That is the only promise any respectable investment advisor can make. No one knows the future. You can only analyse the past and the present. Then, if you find value…you buy. If you don’t, you don’t buy.
Beyond that, the results are out of your control.
Remember that is impossible to do ‘nothing.’ That is not an option. If you have wealth it is always in some form. You are ‘long’ that form of wealth and ‘short’ all others. So, if you say you are in cash, ‘doing nothing,’ you are mistaken. You have your wealth in the form of cash.
This brings us back to the most critical issue of all: asset allocation. What will you be long of? (For a reason unbeknownst to us, old timers use the expression ‘long of’ or ‘short of’ when they refer to their positions. What role the ‘of’ plays, we don’t know. Grammatically, it is unnecessary. But it makes it sound as though you know what you are talking about.)
Cash is not usually a good place to be. In a famous Bible Lesson, recounted by Jesus Himself, the servant who kept his master’s wealth in cash (gold talents buried in the ground) got a beating. And anyone who dared to keep his wealth in US dollars over the last 100 years has lost about 97% of it. Still, there are times when being in cash is not a bad thing. Typically, when other asset classes are overpriced, cash is a good place for your money. You stay long of cash until other assets retreat. Then you put your cash to work.
It is not necessary to do any major macro analysis to figure this out — at least, not in the case of the stock market. As prices rise, you are forced out of positions as they become more and more expensive. That is to say, if you are a value investor, you sell your stocks when they’re no longer good value. Then, if the whole market has been bid up — as it is from time to time — you must do something else with your money. Cash is an option.
Or commodities. Or antique furniture. Or diamonds. Or bonds. Or real estate.
The trouble with these options is that they require a different kind of analysis. You cannot estimate the stream of income you will receive from a Louis 16th armoire because it doesn’t give you any stream of income. You only get the use of it. Commodities follow their own cycles and their own logic. Diamonds too.
And bonds? There, the stream of income is easy to calculate; it is part of the debt instrument. But the value of that stream of income is a whole ‘nuther ball game. It depends on the interest rate, inflation, and the bond market itself.
Central banks have the ability to influence the bond market. So any guess about the future of bond prices must take into account central bank policy. Since it has been the policy of the US Fed to boost bond prices (and equity prices too), for many years, it is probably unwise to expect a further, natural rise in the debt markets.
Real estate is easier from an analytical standpoint. You can usually figure out your return on investment fairly well. But real estate requires more attention. It is a business as well as an investment. And, like any business, it needs active management. You need to get into it and stay in for a number of years before you are capable of operating your business proficiently. Most people don’t have the time, the interest, or the competence to administer a real estate portfolio.
For the typical, sensible, passive investor stocks are usually the investment.
For Markets and Money