Let’s talk about what has happened the last few weeks, or couple of months. And, what lessons we have learned which we can apply going forward, as we think about putting cash flow and assets to work. Before we do though, some perspective and a few thoughts on our approach.
The Pew Foundation, through their research center, www.pewresearch.org, has divided the world population by income. The lowest quintile, referred to as the poor, live on $2 or less per day, and represent 15% of the world’s population. The highest quintile, referred to as high income, live on $50 or more per day, and represent 7% of the world’s population. Close to 100% of you reading this fall in the high-income category. This observation isn’t offered to induce guilt or anxiety over what we have. It is simply to bring perspective. Regardless of what is happening around the world, including the U.S., life is good, in terms of our ability to buffer ourselves from cold, hunger, thirst, or the virus.
Given our relative abundance, how do we engage? We agree with the ancients who offered that to whom much was given, much was expected or required. The philosophy is one of stewardship. This applies not only to cash flow and assets, but to relationships, both personal and professional, and to the world we live in. In fact, the original mandate was to rule and subdue, to assure that all under our care flourished. This hasn’t changed.
In less than 75 days, the Dow has gone from more than 29,000 to 18,600 back to over 24,000. The S&P500 and NASDAQ Composite have followed similar trajectories, with the S&P500 going from 3385 to 2240 to 2875, and the NASDAQ Composite moving from more than 9800 to 6860 to 8730. What’s next? Short-term market timers currently have a preference for gold and bonds, which is bullish for stocks. A Value Line indicator suggests an annualized return over the next three to four years of 8%. The CAPE or Shiller P/E Ratio currently stands at 27, and other measures indicate an overvalued market as well.
So why, until the last 60 days or so, has the stock market been on such a tear, when so many traditional indicators reflect overvaluation? We believe it’s as simple as the fact that investors are looking for a return on their money. Interest rates are low by any historical standard, currently sitting near zero. The two opportunities for most investors, when there is little to no return on CDs and cash, is stocks and real estate. Until recently, this pursuit of return had driven the prices of both stocks and real estate.
What To Do?
The first step is clarity on why. Once this is settled, be clear on time frame, agenda, goals, and objectives. From there, assure that you have a strong cash position. Until the last 30 or 45 days, six months of cash on hand sounded pretty old school. Once that’s in place, set aside in cash or short-term bonds, any funds needed over the next two years, which cannot be accommodated by cash flow or existing reserves. With all that out of the way, you can now focus on the long-term.
Every time the stock market has a bad hair day, some wag will say “this time it’s different”. No. It’s not. We increased our exposure to stocks in late March and early April, in large part because they were under-weight in our models. The basics of this are a sell high buy low approach, which has worked for millennia. And speaking of history, we are fairly certain the stock market hasn’t bottomed just yet. We expect the challenged sectors to continue to be travel, lodging, hospitality, and event venues. We simply don’t know how quickly any or all of us will be ready to engage as we have done historically. While there could be a quick recovery in these sectors, we remain skeptical.
The opportunities appear to be in sectors such as telemedicine, cybersecurity, virology, and sanitation, among others.
We expect a softening of office rents, and a corresponding drop in valuations for office space, over the next three years. The question is how much, which is something time will tell. The opportunities in real estate at this point appear to be in warehouse, distribution, and industrial parks, as manufacturing continues to come back to the states. On the residential side, the opportunities appear to be in high density properties, or those homes designed to house more than two generations.
Keep in mind that our observations are just that. Observations which should be classified as speculation. Our crystal ball is broken, so we have no special insight, other than watching people, markets, and business for the last 40 years. We have found the key to long-term outperformance is good habits, engagement, and attention to detail. If you have questions, or want to talk, you are always welcome to call or email. And, if you know of those who would benefit from an introduction to our team, let us know that as well. In the meantime, wishing you health, safety, and prosperity.