Client Portals

Antidotes To Permabear Narratives6 min read

Skepticism over cynicism

Sep 30, 2020 - Max Osbon ( 8 mins to read)

Max Osbon

Perma-bear is a term used to describe an investor with a perpetually negative view of the future. Perma-bears are worth listening to because they can help us gauge where the worst of the worst risks could be lurking. In aggregate, they attract headlines but their track record has not been positive as they are far more often wrong. Let’s take a closer look at the current perma-bear narrative.

The everything bubble

Perma-bears often warn that “this won’t end well.” – “this” being the big American capitalist experiment. Their warnings may sound like a gift of insight, like a savvy uncle giving you that bit of truth you never quite fully realized but always suspected. Disaster warnings get attention and fear is a significant driver of the news cycle.

It’s a standard narrative that the Fed/Government is ruining our dollar and our economy. The Fed has a long history of printing money. Our government debt levels are at all-time highs and our Fed’s balance sheet has expanded by leaps and bounds over the past 12 years. However, with interest rates at zero, the cost of maintaining that government debt is relatively low. Those 0% interest rates make it cheap for corporations to borrow money and cheap for households to hold mortgages. We break down debt into three categories: government, corporate and household. Even though each category’s total debt amount seems high, each of the three categories can afford their monthly interest payments.

Bailouts and money printing seem unfair. Many argue that it would be better to let our systems fail to teach a lesson to our market participants that risk is real and bailouts aren’t guaranteed. “Don’t fight the Fed” is a powerful motto worth following.

Investors in 2020 aren’t irrationally buying the whole market because money is cheap; they are rationally purchasing companies that benefit from technology and innovation trends. If I focused only on banks, retailers, travel companies and oil, I’d probably be a perma-bear, too, and I’d be far more focused on the concept of an everything bubble.

GDP and unemployment issues

GDP growth and unemployment growth are directly linked to public markets. Expanding GDP and low unemployment supports markets as they essentially create a rising tide that lifts all boats. An interesting metric to follow regarding unemployment is the employment ratio which shows the working population divided by the total population. Unemployment metrics can be manipulated and this helps with the common sense check. 

Rising GDP and low unemployment is not a 100% necessary condition for investors to earn a return. This year we’ve seen the exceptional growth in e-commerce, health technology, cloud computing, digitized finance companies and semiconductors. The revenues and eventual earnings in these sectors are often subscription-based (more reliable than transaction-based) and are expected to grow regardless of what happens next to GDP. Residential real estate has also skyrocketed as people adjust to working from home and mortgage rates dropped. 

Valuations are too high

Another common frustration voiced by perma-bears is valuations. Valuations are almost always too high. Apple’s market cap has been too high for nearly a decade, yet even the most famous value investor Warren Buffet owns Apple at today’s prices (Apple is 25% of Berkshire Hathaway’s value). You rarely get an opportunity to buy a quality company at a discounted price. Like most things in life, it’s worth paying more for quality. The best semiconductor company, the best search engine, the best e-commerce company will command a higher relative valuation than the average public or private business. The best high-growth companies are almost always richly valued. 

The most expensive large-cap companies tend to be expensive for a reason and to remain expensive for a long time. Winners keep on winning and the largest companies often have distinct advantages. 

There is a valuation limit. What is that limit? That depends more on the type of business. Multiples on revenue is a useful metric, as is revenue growth, but that only works for some industries. Sometimes a company is priced so high that perfection is the only path forward and anything less will lead to the destruction of value. We call this “priced to perfection.” It’s not a good place to be. Priced-to-perfection happens less than you’d think and there are easy common sense checks you can use to recognize and avoid that scenario. 

An excellent way to avoid investing in absurdly high valuations is to avoid companies with no revenue. That may seem obvious. Obvious rules are often some of the best investing rules. Many of the SPACs issued this year have no revenue or are extremely unprofitable. Many of these SPACs will probably do just fine, while some will fail entirely. Risk of ruin is not an acceptable risk in our opinion and SPACs deserve much higher scrutiny when it comes to valuation and consideration for investment. 

Buying the best companies in the best sectors with the best management teams is a reliable and straightforward plan that has worked for many decades for the world’s best investors, from Warren Buffet to Phil Fisher to Peter Lynch. That might mean accepting a higher valuation and ignoring the general chatter around high valuations.

Waiting for the crash

As the legendary investor Peter Lynch once said, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

Stocks of all kinds go through periodic crashes. The familiar companies that recover the quickest tend to be the market leaders for some time. Many investors have been waiting on the edge of their seats since 2009 for signs of another crash. During that time, we’ve experienced a technology boom that created incredible software and hardware businesses. These newer technology businesses (many less than ten years old) were the most resilient companies in March of this year when markets sold off. 

It’s not worth risking more than you need or want to. It’s ok to hold onto cash in place of an investment regardless of any anticipated crash, bull or bear market. Defining the right protective reserve in cash, TBills, TIPS, and other protective assets is a crucial step in managing wealth. Diversification will always be a smart investment principle.

Invest through the arguments and protect against the worst-case scenarios

The perma-bears and perma-bulls are at the extreme ends of investor types. They will argue their cases convincingly and they will get the headlines. Investors must protect and grow their capital while positioned in between the two camps. The key to investing wisely is to be aware of what both sides are saying. 

The worst-case scenarios can and do happen. Not often. But they do happen, which is why they are worth considering. Don’t let them dominate your thinking. A useful concept from complex systems theory is to use scenario planning rather than statistical analysis. We don’t have to know the likelihood of an event happening. We only have to know that it can happen. That risk tells us everything we need to know about planning accordingly by putting protective measures in place. 

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