Zero rates for another three years…at least

[7 min read]

You may have noticed I’ve been a little more absent than usual in these pages over the past couple of weeks. That’s because I’ve been working on a new project.

It’s a new service called Greg Canavan’s Investment Advisory. The idea behind it is to provide recommendations predominantly from the ASX 200. It’s designed for those managing larger sums, like superannuation accounts.

The thing is, with interest rates at zero and savers getting absolutely screwed on their deposits, the stock market is really the only game in town for longer-term wealth creation. It always has been, but now it’s even more apparent.

You WILL go backwards if you sit in cash long term.

That’s not to say you won’t experience gut-wrenching corrections and volatility. It’s the price you pay for playing the game and ensuring you don’t suffer from negative real rates.

And just to be clear, rates are likely to be negative for some time to come. As the Financial Review reported following the RBA’s monthly meeting earlier this week:

‘The Reserve Bank has held the official cash rate at 0.1 per cent and maintained the size and parameters of its $200 billion quantitative easing bond buying program.

‘The central bank said it had “brought forward” some bond buying this week to restore functionality to the bond market which had experienced a sell off last week.

‘“Bond purchases under the bond purchase program were brought forward this week to assist with the smooth functioning of the market,” governor Philip Lowe said in his statement.

‘“The bank is prepared to make further adjustments to its purchases in response to market conditions.”

‘The bank said it would maintain “highly supportive” monetary conditions and that the Board still did not expect the cash rate to rise until 2024 “at the earliest”.’

So you’re looking at another three years of this, and probably longer.

That’s why I decided to launch this new project. I wanted to offer you a way of investing that tries to reduce risk as much as possible. The thing is, zero rates and government intervention create risks. You need to counter that as much as possible.

So what do you do when you need to invest in the market, but you don’t want to take crazy risks? That’s the problem I’m trying to solve for you. I’d really appreciate it if you check out my free event, ‘Life at Zero’, and see for yourself whether you think it could benefit you.

The funny thing about nearly free money is that it leads to intense speculation in certain parts of the market. But other parts (many of the boring, traditional stocks) are actually pretty good value. By looking at earnings and cash flows and using a conservative discount rate to value these earnings, there are plenty of stocks out there that should deliver you a solid long-term return.

Yes, there will be volatility and yes you need to accept that and deal with it. But there are definitely good value companies out there right now, despite the feeling that everything is crazy and overvalued.

It’s simply not.

I think it’s just a matter of staying away from what’s hot and popular, and looking closely at what’s not and seeing if there is an opportunity.

That’s not to say you need to be a ‘value’ investor to reduce risk. There’s a problem when you label things like ‘value’ or ‘growth’. Being a slave to a label can get you into trouble.

For example, buying a stock just because it has a low PE or low price-to-book doesn’t mean it’s good value. There’s just as much chance that it’s a value trap. Similarly, buying a stock because it has demonstrated high rates of growth (whether in the form of revenue or earnings) can be a growth trap if, for whatever reason, that growth cannot be maintained.

The truth is, investing is hard today. Much harder than it has been in the past. That’s not just because of the risk of unintended consequences from governments meddling in a broken financial system.

It’s because technology has commoditised information to such an extent that there is no edge to investing based purely on number crunching. It’s often said that investing is part art, part science. That is true. It’s just that the outperformance these days, the ‘alpha’, comes from the art, not the science.

Everyone has the science down pat. If you’ve got a data feed, access to the financials and the charts, you have the same information as everyone else. There is no advantage in that. The value of your approach comes in the thinking.

Howard Marks of Oaktree Capital, wrote about this in his recent memo. I would encourage anyone interested in the art of investing to read it. It’s long, but here’s a snippet:

‘In the past, bargains could be available for the picking, based on readily observable data and basic analysis. Today it seems foolish to think that such things could be found with any level of frequency. If something about a company can be easily read in an annual report, or readily discovered by a mathematically competent analyst or a computer, it stands to reason that, in most cases, this should already be appreciated by the market place and thus incorporated in the prices of the company’s securities. That’s the essence of the Efficient Market Hypothesis. Thus, in the world we live in today, investing on the basis of rote formulas and readily available fundamental, quantitative metrics should not be particularly profitable. (This is not necessarily true during market downturns and panics, when selling pressure can cause prices to decouple from fundamentals.) It also stands to reason that in a time when readily discernable quantitative data is unlikely to produce high-profit opportunities:

‘•if something carries a low valuation, there’s probably a good reason, and
‘•successful investing has to be more about superior judgments concerning (a) qualitative, non-computable factors and (b) how things are likely to unfold in the future.’

In other words, the value is in the thinking and the process that informs your thinking.

If you’re interested in my thoughts about how best to navigate a future of zero rates and constant meddling, check out my special event, Life at Zero.

To get access, go here.

Regards,

Greg Canavan,
Editor, The Rum Rebellion

Bingo Game for Dyslexic Lunatics
Bill Bonner

The gambling goes on. The stakes get higher.

You’ll recall that ‘inflation’ refers to additions to the money supply. When you have a gold-backed system, you can’t really inflate the money supply, because you can’t easily get your hands on more gold.

Typically, the amount of gold above ground increases at about the same rate as the goods and services it is meant to represent. That’s why prices today — in gold terms — are not so different from those 1,000 years ago (with a generous and elastic allowance for technological improvements).

Paper money offers more flexibility — which is to say, it makes it easier to get into trouble.

This was the trouble Thomas Jefferson foresaw, warning that a central bank would emit more and more paper money, and thus bend the nation’s economy away from useful industry towards various ‘species of gambling’.

That has now happened. Since the beginning of the last financial crisis, in 2008, the Federal Reserve’s paper money creation has exceeded GDP growth by some 15 times. And today, on the floor of the Nasdaq stock exchange, the jokers have never had it better.

Classic monetary inflation

We are still in the early stages of ‘inflation’. The Fed creates new money by buying Treasury bonds. Most regular Americans do not own bonds. They are owned by Wall Street…and the rich, in general.

That is, after all, how the rich got so rich. The feds made them rich by jacking up their asset prices. It has nothing to do with them being especially greedy…or with a failure of capitalism.

Instead, it’s classic monetary inflation…as understood by Richard Cantillon, about a hundred years before Jefferson.

Cantillon, an Irishman, was an early investor in Scottish economist John Law’s Mississippi scheme. Law’s Mississippi company was granted a concession to develop France’s colony in North America. This he used as backing for new, paper money emitted by the Banque de France, which he also controlled.

Cantillon, and later Jefferson, saw through the fraud.

The first in line to get the new money are always the rich and powerful. By the time the common man gets it, it is already losing value — fast.

Ahead of the crowd

But for the moment, in the US, the new money is still mostly in the financial markets, where it is making investors dizzy.

Here at the Diary, we tend to be early. We began warning about the dotcom bubble as soon as we began writing our daily blog — in 1998, two years before it burst.

As for the blow up in the mortgage finance industry, we were writing about that as early as 2005 — three years before Lehman Brothers went broke.

Are we now years ahead of ourselves sounding the alarm over the danger of runaway consumer price inflation?

‘You’re way too early to be worried about [consumer price] inflation,’ comments a dear reader.

But we’re not worried about it. We’re just anticipating it. And even looking forward to it, in a cynical kinda way.

Because when the inflation comes, we’ll rest easy. ‘The world still works the way it should,’ we’ll say to ourselves. ‘God is in his heaven. The queen is on her throne. People still get what they deserve. And all is right with the world.’

Huge gamble

Right now, much of the stimmy cheque money is going into the Wall Street economy, not the Main Street economy. Robinhood and other online trading platforms opened new accounts at a feverish pace last year.

This is easy come, easy go money…might as well exchange it for gambling chips.

More fun than a casino — where gamblers at least understand the odds, more or less — the stock market has turned into a sort of bingo game for dyslexic lunatics. Neither words nor numbers need to make any sense.

Here’s Matt Levine, commenting in Bloomberg on one of the lunatics’ favourite stocks:

‘Now Nikola has released the results of the internal investigation and they are…oh, you know. Did Nikola’s founder lie about whether Nikola had produced a zero-emissions truck? Yes, say Nikola’s own lawyers in Nikola’s own annual report to the U.S. Securities and Exchange Commission. Did he lie about whether the truck worked? Yes. Did he lie when he said that all the major components for the truck were made in-house? Yes. Did he lie when he said that trucks were coming off the assembly line? Of course. Did Nikola produce a video to make it seem like the truck could be driven, when in fact it was only moving because it was rolling down a hill? Yes, that is also a real thing that this company really did.’

Used to be, Levine notes, that investors bought companies based on their past performance. Not anymore. The game has changed. Words are dreams…or lies. And the numbers don’t add up.

Investors buy stocks in companies that they think might have a product someday that people might buy and that they might make a profit on…if all goes well.

It’s all a huge gamble, in other words, betting that no matter how big a fool you are, there is always a bigger fool out there somewhere.

Big winner

And thanks to the public school system and the Federal Reserve — it’s a good bet!

Get this — even though Nikola, the electric truck company, has no electric trucks…and even though it lied about its ability to produce one…

…and even though it faces nine lawsuits, six of which have been wrapped into a single class-action suit…

…it is nevertheless deemed to be worth $7.5 billion.

Bingo! You win.

Of course, the big winner of our time is the company run by the world’s second-richest man…which does have a product. And sales.

What it doesn’t have, though, is enough profits to plausibly justify its price — presently just under $660 billion…

Let’s do the math. At its current profit-per-car, TSLA would have to sell more than 25 million of them to make enough profit to meet a modest 12 times price-to-earnings (P/E) ratio. (We’ll ignore the fact that the company lost $775 million in 2019.)

If the total world auto market were about 80 million vehicles, that means one out of every three or four cars sold would have to be a Tesla.

Not going to happen.

All the majors are getting in on the electric vehicle (EV) game. Some are bound to score successes and eat some of Tesla’s lunch.

Big gamble

And then, there’s Lucid Motors. It’s the company that made the batteries for all the competitors in the 2014 EV Formula E race in Beijing. Batteries, it believes, are the key to success in the EV world. And it knows batteries.

Last week, Lucid filed for a $24 billion public listing — peanuts compared to Tesla. But now, it’s decided to go into making electric cars, not just the batteries for them. So it will be running around the same track as TSLA.

Typical of the casino stage, Lucid has no cars to sell. Not yet. It’s all hope and estimations.

In an earlier age, when investors had their feet on the ground, that would have gotten Lucid nowhere. Investors wanted to see actual results — products, sales, profits — before turning over their hard-earned money.

Before they reached that stage, the start-ups had to rely on tougher sources of finance — family money, venture capital, and loans.

But Lucid couldn’t wait. And the markets welcomed them with a SPAC (special purpose acquisition company…a slick way of going public without an IPO) deal that brought them $4.4 billion to get going.

And — unless it is lying — its not-quite-ready-for-prime-time automobile gets more than 500 miles out of a single battery charge, compared to only about 400 for Tesla’s 2020 Long Range model.

New game

TSLA was a groundbreaker. It realised early on not only that you could make a good electric vehicle — everybody knew that — but that investors are no shrewder now than they were in the Mississippi Bubble 300 years ago.

But eventually, they wise up.

When inflation moves from the rich to the common man…from Wall Street to Main Street…and from delightful to obnoxious…

…it will be a whole new game.

Suddenly, investors will learn to spell. And count.

Regards,

Bill Bonner,
For The Rum Rebellion