There is a common saying that time heals almost everything. Yet, even as we embark on the fifth year since the pandemic began, most of
Is It Time To Sell?
Published Date : August 12, 2014
“You wish to surrender to me? Very well, I accept.” – The protagonist Westley in the novel The Princess Bride
In the novel The Princess Bride, later made into a cult film, The Dread Pirate Roberts is not one person but several characters who successively take the same name in turn. The arrangement thrives because of Roberts’ notorious reputation, which instinctively strikes fear into all they encounter, leading to immediate surrender. It is understood, as the story goes, that a pirate operating under his own name would be incapable of creating such a profitable panic. This sets the stage for this rather intelligent succession plan that preserves the fear-provoking brand of the Roberts name over time.
And so it is for investors navigating the markets: the source of investor fear continually changes, but not the emotional response it provokes. Experiencing the feeling of uncertainty is perfectly reasonable, of course, for investors who have had to weather the financial crisis, the European sovereign debt scare and even a downgrade of the U.S. Treasury market in recent years. These have certainly been uncommon times and have left many with a perpetual feeling that the next crisis is just around the corner.
Today, fear takes a variety of names: What will the end of the Federal Reserve’s bond purchasing program mean for interest rates and the markets? Will the first quarter’s rare, non-recessionary, negative economic contraction be the start of a new economic slowdown? Have we reached the point of no return with increasingly burdensome government and consumer debt levels? Surprisingly, even relative ‘calmness’ in the markets has become a fear to many, with overall market volatility ‘too low’ and investor complacency ‘too high’ for some investors’ comfort levels.
Yet the stock and bond markets have performed exceedingly well and in many cases, have recently reached all-time highs. Why has this occurred and what, if anything, should you be doing about it?
There is an old adage on Wall Street that stocks ‘climb a wall of worry,’ meaning that all of the perceived fears of the moment ultimately provide the fuel to propel markets higher as those concerns, one by one, are resolved. While true in a broad sense, in reality perceived fears are only as dangerous as their ability to actually impact global growth or inflation expectations. More often than not, individual headlines are incapable of derailing the world’s natural forward progress. But not always.
Although a gross oversimplification, there have only been three macroeconomic ‘pirates’ over the last half century that have proven capable of ending bull markets and taking our hard-earned treasure. They are: (1) rising inflation and central bank tightening; (2) a banking crisis; and, (3) extreme overvaluation. Rising inflationary pressures and central bank tightening resulted in the bear markets of 1960, 1970, 1974, 1982 and 1990. And of course, 2008 was an historic ‘run on the bank’ credit market crisis that resulted in tremendous wealth destruction of the magnitude not seen for close to a century. Finally, unsustainably high valuations in 1987 and 2000 were the product of stock market bubbles and led to significant wealth destruction in their aftermath.
Presently, most investors appear preoccupied with valuation risk as markets make new highs – yet valuation levels are significantly below the historic peaks that have proven capable of triggering a bear market. While it is true that market valuationhas approached ‘fair value’ by many measures, economic and corporate earnings growth continues to expand. In the case of the bond market, though it appears extended by historical standards, the U.S. market remains relatively attractive compared to even lower interest rates in other developed markets around the world.
The banking industry has made a lot of progress in healing its balance sheets, submitting to higher regulatory requirements and generally keeping its nose out of the more complex leveraged financial instruments that led to the Great Recession’s severity. While margin debt is high and some measures of leverage in the system have returned to 2007 highs, overall, banks have become better stewards of their balance sheets and are unlikely to be the cause of the next downturn as a result.
Finally, we need to consider the most prevalent cause of market downturns: inflation and central bank policy. Of the three trigger points, this is where Sand Hill is currently focused on as a potential trigger that could, at some point, end the current market cycle. While inflation is largely contained to date thanks to a lack of wage pressure and commodity pressure, there is evidence that it is starting to percolate. Concurrently and perhaps not coincidently, the U.S. Federal Reserve is ending its long-standing accommodation efforts and looking towards the next step of tightening interest rates over time. That combination, given the unprecedented nature of central bank actions this cycle, the tightening employment market and rising inflationary expectations, is worth paying attention to in the years ahead. For the moment however, there is little evidence that inflationary pressures are uncontained or that the Federal Reserve is behind the curve in addressing this risk.
It is certainly true that our current recovery remains one of the weakest on record, that geopolitical concerns are on the rise, and that valuation has expanded significantly over the last year. These are trends we are monitoring closely and adjusting for over time when judicious opportunity presents itself. Meanwhile, typical market consolidations shouldn’t be confused with something more nefarious.
At present, none of the three primary trigger points appear capable of undermining our economic recovery, although inflation remains the ‘quiet pirate’ that steals from our purchasing power over time as prices rise. It is a particularly difficult foe to fight in the here and now given the low interest rate environment, but more and more we are pivoting your portfolio with an eye towards increasingly protective investments against rising inflation.
Markets are rarely as black and white and as predictable as a storybook ending, but there are only a couple of pirates bold enough to interfere with your plans to sail peacefully into retirement. Having an investment framework that can cut through the day-to-day headline noise and the associated market jitters, can keep you from surrendering prematurely. After all, even the Dread Pirate Roberts isn’t always what he seems to be.
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