Easy go, easy come. As rapidly as concerns about the market accumulated in the fourth quarter, they dissipated just as quickly in the first quarter. I mentioned last quarter that I expected "dramatic swings", and did we ever get one!
The more interesting takeaway from the sharp turnaround in performance, however, is how unsettled the market seems. The massive “V” shaped move was a far cry from the record low volatility of 2017.
The turmoil in the market also forebodes turmoil in the landscape for investment services. Broadly, there are two different directions the industry can take over the next several years. One is that central banks can continue attempts to support asset prices and succeed for some period of time. Another is that the effort to support asset prices can fail in the relatively near future. There are consequences to both.
In the event support for asset prices fails, investors will be confronted with a landscape very different from the one they have experienced the last ten years. Valuation-based strategies will make a powerful come-back and investors who have cash on hand will be able to acquire assets at low enough prices to provide a high probability of realizing attractive long term returns.
However, this path may prove bumpy. Belief in growth stories is so fervent and disdain for useful accounting metrics is so high that any stock declines are likely to be met with enthusiastic and repeated efforts to recapture momentum, as was the case in the fourth quarter. It could take some time and lots of zigs and zags before the full weight of economic reality decisively takes its toll on stock prices.
In the event support for asset prices continues to succeed for some period of time, there will be a different set of consequences. Investors with intermediate to long term investment horizons can either hope to make their returns while the market is rising, but at risk of realizing a substantial setback that may be hard to recover from, or they can abstain from overvalued markets, but at risk of not realising equity-like returns for a substantial portion of their saving years.
The challenge was illustrated nicely by Grants Interest Rate Observer in it’s April 5, 2019 edition. In the piece entitled, “Cost of low rates”, Grants rightly noted that the rising asset values driven by low rates have also been accompanied by the rising cost of
associated liabilities. In other words, “As interest rates have fallen, the number of dollars required to produce the same level of income has risen.” The burden of such retirement cost inflation is borne disproportionately by younger investors.
So investors face a troubling mixture of ongoing pressues, heightened uncertainty, and existential risks. Unfortunately, many probably won’t realize the challenges in time to implement corrective action.
Nonetheless, such challenges also promise that there will be plenty of work for service provides to help investors navigate the difficult landscape; the only question is to determine the best way(s) of accomplishing that.
That is no mean task, however, because the unusually wide range of investment possibilities requires very different models that in turn, require very different resources and scale.
For example, if the market crashes in the near future, valuation-based active management is likely to be a winning strategy. If valuations don’t materially correct for a long time, active management is unlikely to be especially rewarding. While valuations will not remain high forever, they can do so long enough to compromise most business models, and in many cases already have.
In order to account for such possibilities and also to regularly explore the best ways to serve investors, I have been making an extra effort to reach out to like-minded people in the industry to see if there are ways in which we can help one another. Part of this is just fun for me but part of it involves a serious effort to explore new ways to efficiently share investment expertise.
I continue to believe that there are a lot of things that should be improved in the investment services industry and I also believe that there is a better chance of accomplishing some of those things by working together. More specifically, I am especially interested in finding ways to expand the reach of my valuation work, market insights and research development that are independent of market direction. If you have any ideas of people I should talk to, I would very much appreciate hearing about it.
Thanks for your interest and take care!
David Robertson, CFA
CEO, Portfolio Manager