The latest must read missive comes from Warren Buffett, who eloquently argues that during high inflationary periods, equities as an asset class might be the best house in the worst neighborhood.
It is a public secret that $1 million dollars today is not what it used to be 30, 20 or even 10 years ago. The purchasing power of most currencies has decreased substantially over time as the supply of money by central banks and the demand for credit by the public and private sector have overshadowed the increase in productivity and GDP growth. As a result, investors who have earned 5% a year on their investment for the past 40 years, might be actually in a worse position than they were when they started. Granted, inflation measures cannot account in any way for the technology innovations and improvements in quality that are available today, but nominal vs real return is certainly a topic that needs to be well comprehended by all investors.
Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as “income.”
Warren Buffett continues to publicly bash gold, pretty much calling it the most unproductive asset on planet Earth. I have a slightly different view on the subject as gold could easily be viewed as a currency due to its indisputable liquidity anywhere in the world. Since Buffett started his investment activities in Berkshire Hathaway, gold ($GLD) has increased almost 50-times. This is 13.4% annual return since the Gold Standard was abolished. Of course past results are not guarantee for future performance. In his missive, Mr. Buffett basically claims that gold is in a bubble caused by fear induced, unreasonable expectations:
What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth — for a while….. “What the wise man does in the beginning, the fool does in the end.”
Not surprisingly, Warren prefers investments in productive assets – companies, which earnings power will trump the hidden inflation tax, companies that are leaders in their corresponding industries and require minimum new capital investment – such as Coca Cola ($KO) and $IBM.
The whole piece is well worth the read.
Source: Why Stocks Beat Gold and Bonds by Warren Buffett
$SPY and $QQQ continue to make new highs on almost daily basis as capital has rotated into the energy sector and Oil & gas names have become frequent visitors on the all-time high list.
The trend is still intact.The dips in market averages are short-lived and shallow.Equities still outperform fixed income by a healthy margin; consumer discretionary overshadow staples, signifying improving perceptions of economic growth. Will those expectations materialize is another question, but at the time being the sentiment is optimistic and a good market mood can go a long way.
Under the relatively calm surface, there has been a natural decrease in risk taking. Small caps have slipped against large caps, but the uptrend of the ratio ($IWM vs $SPY) hasn’t been compromised in any way. On the same note, emerging markets have also been lagging as of late.
There has been a slight dip in inflation expectations as ironically the latest positive economic reports have diminished the probability of further quantitative easing. (on a side note, given the monstrous size of banks’ excess reserves, there is absolutely no need of further Fed’s engagement). The trend of the ratio $XLB vs $XLU is still intact and this should be the case in an improving economy.
Another quick way to take the market pulse is by comparing the number of liquid stocks dropping 5% or more in a day vs the number stocks gaining 5% or more in a day. Today, we had 41 pluses and 35 minuses – normal consolidation within a low-correlation market of stocks.
The averages seem extended to the naked eye, but there are no objectively measurable signs of impending serious price correction at this point.
“Every truth passes through three stages before it is recognized: In the first it is ridiculed; in the second it is opposed; in the third it is regarded as self-evident.” – Schopenhauer
Typical market uptrends go through three main sentiment stages:
1) “What bull market? The fall is right around the corner”
Most of the signs of an uptrend are already here – money is leaving defensive names in order to chase higher yield, breadth is improving, correlation and volatility decline substantially. Despite of that, many people don’t believe the rally and prefer to short “overbought” names, only to get squeezed by the tidal wave of monstrous accumulation.
The fastest price appreciation happens in stage 1 and stage 3.
2) Acceptance stage
More and more people gradually warm up to the idea that we are in an uptrend and the market should be considered “innocent until proven guilty. Stocks have been going up for awhile and the minor dips were short lived.
Between stage 2 and stage 3, there is usually a deeper market pullback, which tests the resilience of the rally, shakes weak hands out and allows for new bases to be formed. The deeper pullback is used as a buying opportunity by institutions, which missed the the initial stages of the rally and their purchases push the market to new highs.
3) Everything will go up forever
During stage one, most people are skeptical, because the market has just come from a high-correlation, mean-reversion environment and most are unwilling to see the ensuing change in market character. In stage two, investors gradually turn bullish for the simple reason that prices have been going up for a while. Analysts and Strategists are also turning bullish in an attempt to manage their career risk. In the third stage, most market participants are ecstatic, not only because prices have been going up for a while, but because they personally have managed to make a lot of money. Everything seems easy, the future looks rosy and complacency takes over proper due diligence.