Widely read:
Anand Kumar
At this time of the year, people usually write articles on what the year gone by was like and/or what the year ahead will be like. Last January, I remember writing an article that looked back on 2022 and said it was a 'Good bad year'. By that, I meant that on paper, it looked like it should have been a bad year, what with the war in Europe, an oil price spike, some China COVID idiocy that I can't remember the details of, etcetera. However, despite these events, it was a relatively good year for investors. By the same standard, 2023 was a good year, so by the principle of mean reversion, are we now due for a bad year, or perhaps a bad good year? It doesn't matter.
Most predictions are worthless over a period as short as a year, even though they might make sense over a longer period. Here's a fascinating example. Over the last three years, the consensus Wall Street forecast of the US equity market's performance has been 7 per cent, 9 per cent and 7 per cent. The actual performance was 27 per cent, -19 per cent and 24 per cent. Wasn't the forecast ridiculously wrong? It was, but here's the really interesting thing. Aggregated over the three years, the forecast was +25 per cent, and the actual performance was +28 per cent. So, while the forecast managed to look utterly delusional for each of the three years, the mistake actually lies in the very idea of having an annual forecast because a three-year forecast would have been quite accurate.
Still, larger economic factors have clear trends that can affect investors, the biggest being the cost of money - interest rates. Generally, almost anyone with a voice in economic matters wants lower interest rates, but there are exceptions. A few days ago, my favourite investor-writer, Howard Marks, wrote this fascinating note titled 'Easy Money'. As you would expect from the title, Marks is no fan of low-interest rates and free flow of liquidity to whoever wants it. He argues that while these policies can stimulate economic growth in the short term, they often lead to inflation and asset bubbles that can have devastating effects in the long term. Marks points out that the excessive liquidity of recent years has led to unprecedented levels of corporate debt and an overvaluation of assets, which could spell trouble for the market if interest rates start to rise.
There is a fascinating bit in this letter where Marks uses the term 'long stocks'. The term 'long' here does not mean what it normally does in equity investing but is used as an analogue to 'long bonds'. Here's what he says: Under easy-money conditions, long-dated bonds may appear particularly desirable ... however, long bonds are more rate-sensitive than short ones, meaning their prices change more in response to a given change in interest rates. And later, It seems to me that there's often a similar movement of capital toward "long stocks" when interest rates are low. By this, I mean the stocks of companies believed to have many years of rapid growth ahead. For these companies, more of the projected cash flows are, by definition, in the distant future. Yet, investors may become more attracted to these stocks when rates are low because they want the higher returns that such rapid growth would bring. There's less opportunity cost associated with the long wait for the relevant cash flows ... Just as the prices of longer bonds fluctuate more in response to a given change in interest rates, so-called "growth stocks" usually rise more than others in times of easy money and fall more when money dries up.
It's not a precise analogy, but equity investors should pay attention to whether they are too enamoured with future growth when that growth depends on the continuous flow of cheap money. Just as in consumer products and services, the time for free is gone. Money - especially money over time - is worth more now, and everything being funded for the future will have to be examined closely for real value. The present is more important now, especially the profitability of the companies you invest in.
Also read: Plan (far) ahead for the new year
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