How Do We As Investors Try To Avert The Polar Reach Of Today?
To protect capital and grow our wealth, we must prepare for the cost of capital rising. This is the single most important factor for the next 10-year return of any asset in the world. When writing on speculative episodes, John Kenneth Galbraith wrote “Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present”. The problem for us as investors is that everyone wants to know or justify what is going on now. We should be seeking to think of “the incredible wonders of the future.” A far better question for us is where interest rates will go in the future.
We can already see the effect of the rate rises in real terms for an asset like Treasuries. The chart below shows that Treasury bills haven’t made a real return higher than 2% since 2012. Currency-based investments like bonds will not provide the returns that investors have seen over the last 30 years and will hamper the typical 70-30 balanced portfolio, particularly for retirees. This could be a real problem for that group of investors.
To illuminate why this may be a more important opportunity to ponder a brisk rise in rates, below is a chart showing the year-over-year GDP growth since they began recording the data in the late 1940’s.
This chart shows us that the last seven quarters are the longest streak of quarterly year-over-year growth in the entire period, tying with the early 1990’s coming out of the Savings and Loan Crisis. This is all happening before the fiscal stimulus of the reduction in personal tax rates have flown throughout the economy. The chart shows the strength of the economy is firmer than most believe and may cause rates to rise faster than households expect, affecting stock multiples going forward.
As Jeff Gundlach said recently at the Sohn Conference, “Nothing new ever occurs in the business of speculating. What’s happened in the past will happen again and again and again.” The Gilded Age and today are strong evidence of what Gundlach is saying, or as King Solomon wrote that there is nothing new under the sun. The risk in the United States isn’t low rates and weak economic growth. The risk is that things are better than investors expect and rates rise faster. The risk is that capital isn’t allocated as it should be for normal things to happen in households and businesses. The risk is that polar reach among investors in U.S. tech stocks, futuristic dreaming and the stretch for the Gilded Poles aren’t going to end in anything other than disappointment as it did for Duke Abruzzi, ending his life in exile in Somalia.
Cole Smead, CFA, is managing director and portfolio manager at Smead Capital Management.