Market Inefficiencies Redux: How Falling Prices Do Not Indicate Future Value
On the surface, it is irrational for people to clamor to buy stocks at their highs, and avoid them at their lows: same stocks, same companies, different prices. The change in investor’s expectations can only understand this irrationality. When prices are rising, the expectation is that prices will continue to rise. When they fall, investors expect them to fall further. Logic would dictate that neither position can be true over time. The value of the stock market will not rise to infinity, or fall to zero. Thus what is needed in these times is the ability to think independent of the crowd.
Warren Buffett said as much in his 2017 letter to the shareholders of his firm, Berkshire Hathaway. In that letter he quoted excerpts from the poem If–, by Rudyard Kipling:
If you can keep your head when all about you are losing theirs…
If you can wait and not be tired by waiting…
If you can think—and not make thoughts your aim…
If you can trust yourself when all men doubt you…
Yours is the earth and everything that’s in it.
Academics like to claim that the market is efficient. It is nothing of the sort. If it were efficient, it would not fluctuate as much as it does. Are fluctuations a reason not to invest? Not if your time horizon exceeds the periods of excesses, positive and negative.
Much is made in market lore about buying at the bottom and selling at the top. Such stories forget that the top and bottom are set only in retrospect. When the market makes a top or bottom, nobody rings a bell.
With so much emphasis on the short-term, perhaps value can come from looking at the longer-term. Focusing on industries, the larger airlines, for example, there is little doubt that they will continue to garner their share of domestic and international travel. Oil prices have gone down and come back at least six times in the past decade. No doubt they will do so again. Affluent retirees will demand better lifestyles and healthcare. Someone will profit from providing it. Demography is destiny if you research it right.
Government is a source of anxiety, but it always is for someone. However, historically from a market perspective, a divided government (when one party holds one branch and the other party the other) is shown to be the best environment for stocks. As for issues like the deficits, they will be resolved during some crisis, which is really the only way to change a system of checks and balances. Someone will have to come in and reset the scale.
Is the world in bad shape? Compared to when? There are now more people living in middle-class surroundings than ever before on the planet. Not all countries are democracies, but perhaps not all should be. It takes a certain evangelical perspective to decide that the rest of the world should be just like us. Maybe they should decide what they need to be, and be just that.
There is all manner of human suffering in the world. With modern technology, we can witness it in a way that was not previously available. However, awareness and action are two different issues. Unless the United States is going to become the world’s police, there is a limit as to what we can do. What we need to make sure of is that we are not aiding and abetting the policies of others that are contrary to our nature, by providing the arms or resources to carrying out suffering.
Finally, the immigration issue is not going to go away. Politicians on both sides of the aisle have used it as a way to raise campaign contributions and rally their base. It is time for us to decide if we need the workers, how to enlist them, and whether and how to grant them citizenship, and under what terms. With labor shortages everywhere, the matter of not permitting immigrants unless they hold advanced degrees is preposterous on its face. How many individuals with a PhD wants to cut the grass, or clean the swimming pools? The current labor market is tight enough for all levels of employment. Make the workers register so that they are paid in a manner that collects taxes for the government. Give them the rights that accrue with being a worker in this country, and arrest employers that pay them less or provide less safe conditions for employment, or do not pay the government employment taxes. Have a set time with a workers visa (which would renew with continued employment), and provide a pathway to citizenship within a certain period.
One step to providing more workers has come from the changes to the status of former prisoners in the United States. Hopefully, with greater opportunities after incarceration, and fewer automatic sentences dictated by law, this group will be able to find itself back in the mainstream of society. For the young who found themselves rounded up for victimless crimes like marijuana use, this will hopefully be a new lease on life.
Economic activity is slowing, but not contracting, as expected after the sugar high of the tax cuts in 2017 that mainly went to corporations.
Greater economic growth going forward will depend on domestic worker growth, net exports, and government demand. With a trillion dollar deficit projected, government growth is limited. Exports are hostage to the trade war and its resolution. Domestic workers will depend on the above penal and immigration reforms.
There is some talk of trying to stimulate the economy in 2019 by creating an “infrastructure bank” that would lend funds to states to improve roads and bridges and collect interest and principal on the loans. This arrangement may mean more toll roads, which is better than no roads at all.
Inflation continues under the radar as it shows up more in services than in goods. With the tightness of the labor markets, it seems a matter of time for higher wages, as more people retire and fewer enter the workforce. Immigration and penal reform will help address this, to an extent yet seen.
Interest rates are slated to move higher. Recently, the head of the Federal Reserve Jerome Powell said that while the rate of increases may slow in 2019, the shrinking of the availability of credit in the form of the redemption of bonds held by the Treasury is on “autopilot.” Therefore, the amount of credit taken out of the economy will be in the neighborhood of $150 billion per quarter for some time.
While this will mean higher interest rates, it will also mean more income on bond investments. Often overlooked is the extent to which the low interest rates impacted the elderly, and as a result, forced them into the stock market. As interest rates return to their normal range of 4-6 percent, look to see more retirement funds diverted to bonds from the stock market.
The Stock Market
The stock market exists in a state of confusion. There are some owners of index funds that have no compunction dumping them, as they have no real knowledge of what they own. The last of the market sectors to decline; utilities, consumer staples, and healthcare, all have gone south in the past ten days.
With almost the entire market down, a case can be made for a rally of some caliber in the near future. Longer term, competition from higher interest rates and slower earnings growth for most sectors will make it more of a market of stocks, as opposed to a stock market.
Warren M. Barnett, CFA
December 20, 2018
Warren Barnett is the founder and President, and Portfolio Manager for Barnett & Company. He was associated with the investment banking firm of Kidder, Peabody & Company and the investment counseling firm of Davidge & Company in Washington before returning to Chattanooga to accept a position in the trust department of a local bank. Perceiving the local need for the type of firms with which he was associated in Washington, he established Barnett & Company in 1983. He obtained the Chartered Financial Analyst professional designation from the Institute of Chartered Financial Analysts, Charlottesville, Virginia in 1986. Mr. Barnett graduated from The McCallie School in Chattanooga. He received his Bachelor of Science degree in Accounting from the University of Tennessee at Knoxville and his Master of Business Administration degree in Finance from the Owen School of Management at Vanderbilt University.
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