EdgePoint Podcast: Tye’s takes on 2020
Tye recently did a 30 minute investor-friendly interview which is now available in an easily downloadable podcast. Tye discusses:
1. Why short-term underperformance is required for longer-term outperformance
2. 2020 performance: a tale of two markets
3. Why we won’t invest with the herd
4. Our ongoing commitment to getting your clients to their Point B
5. Tesla, TE Connectivity and more….
Download it now
or listen on Apple or Spotify
Comparing investors to frogs in boiling water
Seth Klarman, the founder of hedge fund Baupost Group, has told clients central bank policies and government stimulus have convinced investors that risk “has simply vanished”, leaving the market unable to fulfil its role as a price discovery mechanism.
Mr. Klarman also said the Fed’s policies had exacerbated economic inequality, referring to a “K” shaped recovery that has seen “the fortunes of those already at the top bounding swiftly upward, while those at the bottom remain on a downslope without end”.
“With so much stimulus being deployed, trying to figure out if the economy is in recession is like trying to assess if you had a fever after you just took a large dose of aspirin,”
“But as with frogs in water that is slowly being heated to a boil, investors are being conditioned not to recognise the danger.”
Using Tesla as an example, Mr Klarman said shares in the “barely profitable” electric carmaker had soared “seemingly beyond all reason”, briefly making the company’s founder Elon Musk the richest person in the world. Low interest rates have made projected cash flows more valuable, he said, a point many investors have unwisely used to justify valuations on companies that sit far above historic norm.
Investors used to love “story stocks.” Now they love story ETFs.
Often called thematic ETFs, these funds cut across industries, trying to capitalize on ideas like alternative energy, cloud computing or 3-D printing. Others buy stocks that could benefit as more people work from home, demand gender or racial diversity, or lavish money on their pets. Assets in these funds have grown at an average of 45% annually over the past three years.
In the fourth quarter of 2020 alone, thematic ETF assets shot up 78% to $104 billion. Quirky rules of portfolio construction can also crop up. At the U.S. Vegan Climate ETF, the size of any single stock position is limited to 4.5%. Yet Tesla Inc., the fund’s largest holding, has mushroomed to 7.9% of total assets.
Investors pursuing themes that seem obvious should remember that if a theme appeals intuitively to you, chances are it appeals to millions of other investors too, making a fund’s underlying holdings more expensive.
These funds tend to launch months after a theme has gotten hot—amid a crescendo of media hype and stocks earning eye-popping returns. In other words, investors have a natural tendency to buy at exactly the wrong time, and these funds can make that even worse.
“Well, I’ve got a tip for you. If you think you’ve spotted a theme that other investors haven’t fully appreciated yet, ask yourself how come there’s already a thematic fund for it.”
When Investors Forget Fundamentals
This year, stocks priced below $1 have performed the best, followed by those between $1 and $2, and so on. It looks remarkably like investors are treating a low-price share as an indicator that the stock is a bargain, and a higher price as a sign that it is worse value for money.
The share price on its own carries virtually no useful information: It depends entirely on how many shares the company has issued.
The pattern of lower-priced stocks doing better is perhaps brought on by the rising popularity of trading by individual investors, who are more likely to be new to the stock market and regard a low-price share as cheap, even though it should be irrelevant to a company’s prospects.
This week’s charts
Who needs earnings?
Global stimulus in response to COVID-19
The balance sheets of developed market economies are now approaching wartime conditions
Investing…it’s just that easy
Chad and Jenny are the newest financial stars of TikTok. As Chad puts it: "I see a stock going up and I buy it. And I just watch it until it stops going up, and then I sell it. " "Up is good. down is bad. I just ride the upward trends and when they start going down jump off lol."
In a bull market, lots of stocks go up. You can probably find a few even if you have no clue what you're doing. As the old saying goes, even a blind squirrel can find an acorn once in a while.
In the late 1920s, trading stocks, often with borrowed money and without doing any research, became a national obsession. The same mania struck in 1999 and early 2000.
Investing can be simple, but it isn't easy. It isn't a mindless joyride. It is a process, not a game; you win by persisting over the course of many years, not by racking up the most points in the least amount of time.
Being cooped up has led many investors to conclude that they can perceive which themes, or broad trends, are likely to dominate the market for years to come. That can make it harder to remember that other investors may have spotted the same themes even earlier, driving prices dangerously high.
You should keep your investing simple. But you should never let anybody fool you into thinking that investing is easy.
