Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
When Safety Is Dangerous
Earnings season is beginning to wind down, and the impression we get from corporate reporting and economic data is one of resilience. While the tone of many of the conference calls we have listened to is sobering, and highlighted the very uncertain nature of forward-looking estimates, many of the companies on which we are focused have done a very good job dealing with the controllables. Indeed, many companies have still not issued 2020 guidance at all, or revoked it earlier in the year given the incredible uncertainty around re-openings, “second waves,” and generally low levels of consumer confidence. However, despite pockets of real stress and, in some cases, distress, resilience of the overall economy is a key theme.
Through this lens, it is seemingly impossible not to own risk assets, particularly when the investment alternative is negative real yields brought about by easy monetary policy. It is quite a conundrum for risk-averse investors, particularly those who are retired or are near to retirement, for whom preservation of capital is a priority. Negative real yields effectively imply that holding cash will not allow investors to maintain purchasing power over time. Apparently safe investments, over time, are indeed not safe. This forces otherwise rational investors to wholeheartedly embrace risks they would otherwise not feel comfortable taking. In an environment such as this, antiquated notions around valuation fail to matter.
There are many well-paid market pundits who believe that the markets and investors are completely irrational, and the current market environment is nonsensical. However, through the lens of the preservation of purchasing power the market environment is indeed quite rational. Investors cannot at all earn a yield that will support their cash flow needs from a fixed income portfolio. For that matter, the vast majority of companies in the S&P 500 earn between a 1 to 2 percent yield. As of today, it was 1.82 percent.
In order to build a portfolio with more significant yield, one is forced to take on risk of economic cyclicality, credit risk, the risk of a dividend cut, or all three. However, investors are eager to do so because they understand that their alternative is to watch their purchasing power decline. In a world of negative real rates, the perception is, literally, any asset is better than cash. The market herd does not differentiate between precious metals, which we believe are monetary assets, and the stocks of bankrupt companies.
No one can predict when this will end. It is quite clear that the COVID crisis is by no means over, and will likely bring about a series of other crises that will need to be dealt with by policymakers. Ultimately, the “endgame” depends on how sustainable negative real yields are over the long-term. This is largely a factor of market confidence in policymakers to supply enough liquidity to ensure that asset prices continue to rise and maintain financial market stability.
If you look at the stock market over the last few decades, barring what appears on charts to be nothing more than hiccups, the monetary experiment has thus far been successful. In the meantime, ironically enough, those who may perceive themselves to be taking the least amount of risk are actually risking their future purchasing power. Ultimately, this policy does more harm than good societally, as currency debasement is the most regressive of all taxation schemes. It hurts the banking sector and their ability to make a return on their assets. Capital preservation in the form of cash is, for now, an illusion.
Best Regards,
David McAlvany
Chief Executive Officer
MWM LLC
