June 22, 2021
I’m feeling like a dinosaur these days. I’m not a believer in cryptocurrency. Cannabis stocks look like the Wild West to me. Rapid day-trading always ends badly. Options are more like detonators than silver bullets. And if that’s not enough, I still think profits matter.
It’s a lot like the dot-com era. In 1999, I was a newly minted CEO at a large asset manager when one of our most influential clients phoned to say, “Tom, your firm is no longer relevant. The world has changed.”
Needless to say, I did some soul searching back then and I’ve been doing some more lately. My first step was to figure out which investment canons I still believe to be true.
I started with the basics: An investment’s value is based on its future stream of cash flows. The price of a stock has to eventually reflect the value of the underlying business.
The stock market can’t be predicted with any precision. This hasn’t changed despite a plethora of confident forecasters. You shouldn’t be surprised if stocks are up another 20 per cent a year from now or down by just as much. Basing investment decisions on where you think the market is going is still folly.
Markets consistently overreact. Stock prices are considerably more volatile than revenues and profits. They regularly go further than the news would justify. Sometimes, way further. This can be disconcerting, but for investors who have time and a good sense of value, it reeks of opportunity.
My late partner, Bob Hager, used to say: If you’re looking for perfect information, you’ll miss the market. You risk missing out on the bulk of a price recovery if you wait for certainty. The market will bottom well before a recession, crisis or pandemic is declared over.
Related to this, you make most of your money in bear markets. You just don’t know it until later. Bob claimed that his best trades were the ones when his hand was shaking as he gave our trader the buy order. There isn’t much good news to lean on when stocks are down, which makes for conservative forecasts and low expectations. This is a beautiful combination, as the recent rebound in cyclical stocks demonstrates.
If in doubt, it’s cyclical. We all want to catch the next emerging trend (i.e., mobile, social media, cloud computing), but most trends are cyclical in nature. Too much or too little of something will create the opposite circumstance. Weak demand and low prices cause shutdowns, less investment and, ultimately, shortages. The price explosion of lumber, used cars, semiconductors and shipping containers is not a reflection of paradigm shifts, but rather repeated cycles.
And while we’re on that theme, cycles that go on for a long time and reach extreme levels don’t end with soft landings. Years of expansion and, eventually, excess take time to work off. On this one, the rule is being tested because near-zero interest rates and government largesse have extended most cycles.