This investment column is all about disclosure and ensuring readers that I back up what I write with my own money. Hundreds of you have emailed since my intro hike last week asking why I chose the funds I have.
Fear nothing. Over the coming weeks and months we will be exploring every major asset class under the sun. But when it comes to putting an idea into practice, the sad truth is that many of us are limited in our choices.
For example, my Aviva pension only offers a dozen funds. If that wasn’t pathetic enough, the largest and second most successful stock market in history – the United States – doesn’t even make the list. (The reader who emails me the best since 1900 gets a gold star). It’s almost as if the trustees of the plan meet quarterly for the sole purpose of denying their members early retirement. Hands up to anyone who thinks we should include an S&P 500 fund. I didn’t think so. How about a short-term credit fund? Unanimous!
This is why I was forced to buy BlackRock’s global (ex-UK) equity index fund on September 29 this year. I had been sitting in cash, or rather a sterling cash fund, since January, and with US stocks down nearly a quarter, it was a good time to step back. Everyone was bearish and moaning their heads – usually a buy signal. Although not pure play, US companies make up 70% of the fund. It was the closest I could get.
I also wanted a few mega-cap US tech stocks, which had fallen even more than the broader market, but not too exposed. Apple, Microsoft, Amazon and Alphabet are all in the top 10, but it’s still a globally diversified fund. I chose the ex-UK version as I already owned a UK fund, which we covered last week and will come to in more detail shortly. So why was I happy to add US stocks to my portfolio? Most strategists remain bearish. Answering this question also requires a view of tech stocks, given their large weighting.
Whether the technology is in secular decline or just faltering is currently the subject of much debate. My colleague (and greatest employee of all time) Robert Armstrong summed up the arguments well in his Unhedged newsletters. Much depends, it seems to me, on a simple question. Do good old-fashioned valuation techniques work for big tech? If so, the sector remains expensive. On the other hand, if you think these companies are walking on water and transcending the usual analyzes based on earnings, balance sheet and cash flow, lower prices are a chance to stock up.
While I’m wary of believers (every bubble tells me why traditional metrics don’t apply), I also know that the even more widespread view that higher rates caused the tech to sell out is wrong. It is very important for readers to understand this because we hear all the time why higher rates are bad for stocks. Indeed, the main reason cited for this latest mini-bounce is hope that the Federal Reserve won’t be as aggressive on rate hikes from here.
This is however not a straightforward subject and involves some understanding of business modeling. One of the ways I explain to new analysts why rates don’t affect valuations was inspired by an interview I read with a famous hotelier when I was living in New York during the financial crisis. (I’m sure it was Ian Schrager, but capitalism was supposed to end back then, so I was pretty distracted).
He claimed never to worry about the economy. In good years, more guests come through the door. In downturns, however, staff, laundry, food and furniture are cheaper – and potential new sites are good business. It balances out in the end, he said.
Likewise, the reason so many people misunderstand the relationship between interest rates and stock prices is that they forget that rates reflect future states of the world. They rise when an economy is thought to be warming up and come back down when expectations subside. Growth and rates cannot be separated, just as it is more expensive for Schrager to decorate his rooms when they are full.
And yet, people constantly separate the two. Financial writers and analysts like to show how smart they are by reminding us that a company’s value is derived from its future cash flows. And it is indeed the case. They then go on to claim that if this flow of money is “discounted” at a higher rate, its starting point must be lower today – a company’s net present value is decreasing, using the jargon. Conversely, if interest rates fall, stock prices must rise.
But that’s only half the story. You can’t just change the discount rate in your business model and not adjust revenues in future years. It would be like Schrager bragging about how much money he would make because costs had gone down, without assuming that bookings would follow. When I was a young equity analyst, we sat around a table with our models and one of the first things we checked was whether our discount rate was consistent with our revenue growth estimates. business.
Higher interest rates must be offset by higher income lines and vice versa. Valuations remain unchanged. Inflation also pushes incomes up. That everything balances out in the end is not just theoretical. Look at a long-term chart of stock prices and interest rates in the United States, for example, and you will see that there is no relationship.
Of course, over the past two decades, borrowing costs have fallen while stocks have soared. But in the 1950s and 1960s, rates and stocks rose together. Go back and read the financial press of those decades and everyone thought that was the norm.
No, I wanted exposure to US equities because they should be the core of any portfolio. They’re cheaper than they used to be, and I’m happy to ignore the higher rate doom dealers. So should you.
The author is an investment columnist and former banker. E-mail: [email protected]; Twitter: @stuartkirk__
