In our business and investing commentary to clients this month we highlighted the dramatic impact that low interest rates and Federal Reserve monetary policy have had on financial assets since the global financial crisis (what investor Howard Marks recently referred to as “the dominant feature of the world of finance over the last ten years”(1)). The contribution of falling interest rates to historical returns for many assets has been enormous. I suspect this point is lost on most investors. Why? Because allocating capital as if the status quo will hold and the next ten years will look like the last ten ignores this fact – unless one believes that rates in the US are going to zero and will remain there indefinitely, and nothing else will change.
Our view is a little different. The following quote captures my thinking on this topic so well that I’ll just get out of the way and share the quote:
“Few would argue that the Federal Reserve has had a growing influence on market behavior. However, there is considerable disagreement among investors about whether central bank intervention is sustainable without culminating in another financial crisis. Even those genuinely concerned about the long-term consequences of Fed actions are mostly still unable or unwilling to position their portfolios today for a less hospitable market climate – the opportunity cost of sitting out potential gains is too great and clients expect results now. Without a doubt, an unconventionally managed portfolio is a tough sell after a decade when it has appeared totally unnecessary. We believe business and market cycles are cyclical in nature and this time is not different.”(2)
I do not know what will cause other investors to change course. To – as one investor put it – “sell a little Microsoft at 35x earnings and buy a bank or any of the other unloved areas”(3) - but it seems obvious to me that if ever there was a time to remain true to our philosophy, this is it. That philosophy is simply to protect capital first and put capital to work when the odds are in our favor. We are seeing some places where risk/reward is more attractive, but those tend to be private opportunities where there is less capital and less competition.
There’s always stuff to worry about. I just want to be well-compensated for assuming risk. I want to be confident I can get my money back, or only lose a little, if things don’t work out. I’m looking forward to a time when those kinds of opportunities are more abundant.
1. Howard Marks Memo “On the Other Hand,” July 26, 2019.
2. Palm Valley Capital Fund Second Quarter 2019 Commentary.
3. Artisan Global Value Fund, Quarterly Commentary, June 30, 2019.