95% Undateable

You can learn a lot about investing by watching Seinfeld. In season 7 episode 114, Jerry and Elaine talk about the lack of dating opportunities. Although they were talking about the percentage of the population that is undateable, by making some minor changes to the script, their conversation fits the current investment environment perfectly.

Jerry: Elaine, what percentage of people [stocks] would you say are good looking [attractively priced]?

Elaine: 25%

Jerry: 25%? No way. It’s like 4% to 6%. It’s a 20 to 1 shot.

Elaine: You’re way off.

Jerry: Way off? Have you been to the motor vehicle bureau [screened through stocks]? It’s a leper colony down there [horrendous opportunity set].

Elaine: Basically what you’re saying is 95% of the population [the stock market] is undateable [overvalued]?

Jerry: Undateable [overvalued]!

Elaine: Then how are all of these people getting together [why are all these people buying stocks]?

Jerry: Alcohol [Quantitative Easing]

While the ECB announced this morning that it will be reducing the amount of bonds it buys from 80 billion euros to 60 billion euros a month, it also made clear that they are willing to increase and prolong their QE program if necessary. The BOJ also remains committed to a prolonged period of QE and continues to do whatever it takes (monetize as much debt as necessary) to keep their 10-yr bond near 0%. And what about the Federal Reserve?

There was an interesting article on Bloomberg this morning titled, “Fed Officials Leaning Toward Bigger Is Better on Balance Sheet” (whatever happened to the exit strategy?). The article states that the Fed’s “new tools” and expanded balance sheet will be “a more permanent feature of the way they interact with financial markets.” First, monetizing debt is not a “new tool” – it’s been around for centuries. Second, “permanent” is a powerful word. Permanent assumes policy makers can control financial markets indefinitely. That’s a very bold assumption and not one I’m comfortable relying on when allocating capital and valuing risk assets. Simply look to the current rout in the bond market. Whether the spike in bond yields continues, I don’t know, but I continue to believe this cycle’s “monetary policies without limits” will ultimately be considered counterproductive. At that time I expect investing (as I understand it) and free markets to return. Until then I plan to wait and wait some more.

I was asked yesterday how I felt about being left out of the market and continuing to incur opportunity cost. It’s not pleasant, but it doesn’t bother me too much. I’m confident that this market cycle will end – history is very clear about this. While I don’t know when this cycle ends, I feel appropriately positioned regardless of how the market moves in the near-term. For my process and discipline to be rewarded, the heights stock prices eventually reach is irrelevant. Prices can double or triple from here. The values of the businesses I follow don’t change meaningfully.

Most of the companies I expect to own again are mature businesses. Their valuations shift slowly with cash flow retention and capital allocation. As small cap stocks spike higher, the disconnect between price and business value grows. As the gap between price and value expands, the more volatile and disorderly the eventual closing of the valuation gap will become. In my opinion, the higher prices go, the higher the level of distress and opportunity during the next bear market.

The tech bubble is a great example. As a patient buyer refusing to overpay, did it really matter how high the NASDAQ ultimately traded? During the tech bubble the NASDAQ peaked at 5132 on March 10, 2000 before collapsing to 1108 on October 10, 2002. In hindsight, the NASDAQ could have topped out at 10,000 or 20,000. The ending, or collapse, would have occurred regardless of how high tech stocks traded. The insane prices tech stocks reached in March 2000 provided no protection for investors who rode them all the way down to their lows in 2002. Similarly, how high stocks trade today provides little to no information on what their underlying businesses are worth or what patient buyers will eventually pay when the cycle ends.

In conclusion, it is the prices I ultimately pay for businesses at the end of the cycle that concerns me, not how high prices go or where they peak. As such, let em rip! As I always say, buy, buy, buy!