Think Like a Shareowner, Not a Shareholder
There are many factors contributing to the selloff over the last year and while it is hard to nail down one factor (in addition to company specific fundamentals), stocks have been sold because of inflation fears, followed by aggressive interest rate increases, which have then contributed to global recession fears (lower earnings expectations), further pushing stocks lower. There are also geopolitics with the war in Ukraine, the strain in US/China relations and a number of other factors that have impacted share prices.
Bond yields/interest rates moving higher this year impacts share values since a stock is the value of its discounted future cash flows. Investors will then estimate a company’s future cash flows and pay a multiple for the expected growth rate.
Part of figuring out that valuation is what interest rate investors will use to discount those future earnings. With rates going up, investors worry that the discount rate needs to go up, which means those future earnings are worth less. Stock prices have moved lower as a result.
However, when inflation peaks and rates start to move lower, the headwind will become a tailwind. In Canada, long bond yields have largely been flat over the last couple of months, while short term rates have moved higher resulting in an inverted yield curve, which is when short term rates are higher than long-term rates. U.S. 10-year bond yields are nearing 3.5% and a 2-year bond is close to 4.00% this week.
While a concern is that bond yields will continue to move higher, investors that need income in their portfolio are starting to find much more attractive yields along with the potential for capital appreciation as a result of lower bond prices. It is also possible that investors who are looking at an economic slowdown are finding value in the bond market as a defensive asset allocation.
We will never know when the peak in rates will occur until after the fact. While it is often pointed out how difficult it is to ‘time the stock market’, the same holds true for the bond market. At the historical low bond yields we saw in 2020, it wasn’t too difficult a call to say bond yields would move higher. Now that bonds have sold off and we have higher bond yields, the big question is whether the next move from here is higher or lower for bonds prices. It is very difficult to time both a buy and sell call and get them both right.
Think Like a Shareowner, Not a Shareholder
It’s been a difficult year for investors. I am referring to those that want to own companies for the medium and long-term benefits such as collecting dividends. Recall that to collect a 5% dividend yield, one must own a company for the full year, receiving the monthly or quarterly dividends along the way. Those that don’t attempt to trade the market recognize the challenges such as ‘how low is low’, and ‘how high is high’ when buying or selling. One might buy a stock at $100 and think a month later, as the share price is lower, that they should have waited. In a year or two, it might not matter.
In a down trending market, it seems easier, but nothing in investing is easy. It should come down to whether you want to own the shares of the company or not, rather than trying to buy at the ‘best’ price. The day-to-day machinations of the market can be a result of many factors, some of which have nothing to do with how a company is doing. For example, computerized trading can move stocks around, based on the headlines or fund flows of the day.
For a long term investor, you own a piece of a business. What if you owned the whole business? Would you worry each day about the value of the company or would you focus on running the business? It makes a huge difference not knowing the day-to-day value. An owner wouldn’t be checking the company’s valuation each week or month if he/she had planned to hold the company indefinitely.
Despite a downturn in a business or an economic cycle, if you had the right management team and people in place, you might even be excited about the opportunities ahead for the business to still grow and to take market share. Someone wouldn’t sell the business solely based on the valuation of the company if it were temporarily depressed, especially if they were happy with the opportunities and future growth prospects. Would you worry about the macro or focus on the business?
The stock market, for better or worse, provides us with a daily share price, which is often not what a company is currently worth, or will be worth in the future. There are many reasons that share prices fluctuate and not are all company-specific. We don’t constantly check housing prices, so why react to daily share price changes, knowing that the business such as a bank, pipeline or software company doesn’t alter that much from day-to-day?
We never actually know that a new bull market has started until well after the bottom.
It's easy to look back and pinpoint the March 2020 low or the March 2009 low, for example, and say, "That's when the bear market ended and a new bull market started".
But in real time, when we are going through that transition, how can we possibly know?
Classic signs of the end of bear markets are indicators such as historically bearish sentiment extremes (nobody thinks the market will ever get better…) and washout breadth levels (most stocks become highly correlated and fall together, regardless of their sectors). Another signal can also be relentless buying pressure in face of largely negative news that is already ‘known’ or factored into markets. Investor skepticism, despite the buying pressure, usually continues. Investors ignore these signs, waiting for ‘better news’ to confirm the bottom. However, often we will see where news follows price and will arrive later, well after the recovery has already begun.
CNBC: Buffett's timeless advice when stocks are falling
I enjoyed reading this timeless advice from the 2020 Berkshire shareholders’ meeting, when Warren Buffett discussed that an investor can’t be scared when everyone else is scared in the stock market.
"If you have a temperament that when others are fearful you’re going to get scared yourself, you know, you are not going to make a lot of money in securities over time, in all probability."
"You know, people really — if they didn’t look at quotations — but, of course, the whole world is urging them to look at quotations, and more than that, do something based on small changes in quotations."
"But think how much more rational — we’ve talked about it before — but think how much more rational investing in a farm is than the way many people buy stocks. If you buy a farm, do you get a quote next week, do you get a quote next month? If you buy an apartment house, do you get a quote next week or month? No, you look at the apartment house or the farm and you say, 'I expect it to produce so many bushels of soybeans and corn, and if it does that, it meets my expectations.'"
"If they buy a stock and they think if it goes up it’s wonderful, and if it goes down it’s bad.
"We think just the opposite. When it goes down we love it, because we’ll buy more. And if it goes up, it kills us to buy more.
"And I — you know — all kinds — you know, Ben Graham wrote about it. It’s been explained. But if you can’t get yourself in that mental attitude, you’re going to be scared whenever everybody else is scared.
"And to expect somebody else to tell you when to buy and therefore get your courage back up or something, you know, I could get this fellow’s courage up substantially by saying this is a wonderful time to buy, and then a week from now he’d run into somebody else that tells him the world is coming to an end and he’d sell.
“He’s a broker’s friend, but he’s not going to make a lot of money.”
Favorite Recent Reads:
How the Worst Market Timer in History Built a Fortune: A story on the magic of compounding with a hypothetical example of how a poor investment market timer would still do very well even if they always bought at market peaks with a diversified portfolio and reinvesting their dividends.
The Illusion of Knowledge - Oaktree Capital: There are no shortage of macro forecasts. Howard Marks looks at the challenges with making macro forecasts and the difficultly for an investor to follow such outlooks.
Money Managers Starting to Eye Treasury Bonds Again With Yields Spiking: Some asset managers are becoming more constructive on fixed income, after the selloff in bonds.
Navigating the Pain of Your First Bear Market: While difficult to ignore the negativity, a few tips on how to manage a bear market.