The current low interest rate environment increases the discounted present value of future cash flows and reduces the return demanded for every investment. In other words, when the Fed funds rate is zero, 6% bonds become disproportionately attractive. Buyers have now bid bond prices up until yields are now significantly less. What does it mean if the prices of stocks and listed credit instruments are at levels not driven primarily by fundamentals reasons (i.e. current earnings and the outlook for future growth), but in large part because of the Fed’s buying, it’s injection of liquidity, and the resultant low cost of capital and the market’s lower demanded returns on financial instruments? My conclusions are limited by inadequate foresight and influenced by my optimistic and pessimistic biases. Experience teaches it is hard to get the answer right. Or, as Charlie Munger has said, “it’s not supposed to be easy. Anyone who finds it easy is stupid.” At the risk of being stupid, equity investments in companies, including the five largest, with the unique competitive positions and “closed-loop” business models will remain excellent investments. In addition, certain fixed income securities paying high yields with attractive long-term risk-adjusted safety are extremely attractive and are being ignored in this unique interest-rate environment. This combination will create substantial value. Unique macro forces created by the central banks, unprecedented and sustainably low interest rates combined with pandemic-tested sustainable business models have created truly unique opportunities.
We are rapidly approaching a zero-interest rate world. Interest rates are being driven to zero (or below zero in many cases) as a first-line tool for central banks to generate economic activity in the face of the dramatic negative impact of the pandemic, as well as existing and lingering economic fallout. This toolbox will be empty soon, and the only remaining weapon will be fiscal policy. Among other things, fiscal policy and domestic financial markets will have an overwhelming influence on global currencies. Capital flows will dramatically impact currency volatility as capital moves to more attractive countries with more liquid and robust asset markets.
The government is providing a backstop for all government-backed securities. The Fed is also going to be extremely active in the markets, buying not only fixed-income securities but also stock index funds. They are working very hard to keep the market aloft and preventing it from cratering (they still may not be successful). This is an election year and this administration will do everything it can to make sure things look as good as possible through November.
I understand there is riskiness, but I expect economic activity and fed support to continue to increase. Even if we have an increase in coronavirus cases, people will remain optimistic – justifiably or not.
There will be extreme volatility. Economic activity will waiver, increase suddenly, pull back, and the pattern will continue for some time to come.
Market volatility is our friend because we have a stable source of cash flow that protects our capital base. On top of that, the speculative strategy will profit from volatility while the equity investment strategy will play for the long term – it is a multi-year long-term perspective.
Although there are a handful of investments where confidence in the five-year curve is justified, and now is a great time to make these long-term investments, it is still very unpredictable.
The short- and long-term state of the economy, how this massive amount of debt gets repaid, how we reopen businesses, etc. is unknown, volatile, and any attempt to predict seems fruitless. But, understanding how to adjust for risk, accept, and ultimately take advantage of volatility, will be powerful. Along with a long-term perspective, this will be the most effective investment strategy. The Fed is printing more money. We’re going to see a lot of capital injected into the global economy. But the presence of money is not the important factor. It’s the velocity of money – how people are spending it and is that money chasing after other goods. That will drive inflation. We didn’t see it in the past even though we had a massive capital injection. Deflation and recession are much bigger concerns. Inflation is not on the horizon. The Fed’s enhanced bond-buying, which includes high-yield bonds and other fixed-income securities is unprecedented and has boosted the value of debt portfolios. However, these portfolios (mostly just above or just below investment grade) still yield attractive disproportionate risk-adjusted returns.
Chinese economic policies and motivations since 2008 not only emphasize growth and sustainability of state-owned enterprises but, a critical but much less well-appreciated dimension is the Chinese government’s emphasis on stability. No economic policy in China will ignore this, and the high value placed on stability pervades all the current trade talks with the United States.
High growth companies competing for large total addressable markets may not be creating long-term value. Cheap capital has created a vicious circle of unproductive investment. Markets will correct this overvaluation and misappropriation with a rather unpleasant bang.
Biotechnology has been beaten up a lot lately and has had a very volatile and unimpressive recent history. However, biotechnology is still one of the single greatest investment opportunities available, and new and exciting factors are developing and enhancing the attractiveness of the sector