There is an inexplicable calm in the market. Have you noticed? Volatility appears to be under control. Many investors, it seems, are happy to toss money into the market with gay abandon. According to the CBOE VIX index – otherwise known as the fear gauge – investors are without fear. The index is currently sitting at around its lowest level since inception. Stocks markets in just about every corner of the world have been rising, in spite of political turmoil in the US. Does anyone really know what is going on in the White House? What has happened to the…
There is an inexplicable calm in the market. Have you noticed?
Volatility appears to be under control. Many investors, it seems, are happy to toss money into the market with gay abandon. According to the CBOE VIX index – otherwise known as the fear gauge – investors are without fear. The index is currently sitting at around its lowest level since inception.
Stocks markets in just about every corner of the world have been rising, in spite of political turmoil in the US. Does anyone really know what is going on in the White House?
What has happened to the repeal of the Affordable Healthcare for America Act? What has happened to US tax reform? What will happen when America hits its debt ceiling again.
Meanwhile, stock market bulls have been rampaging, despite North Korea’s continuing threats to fire missiles at the US. Notwithstanding China’s best efforts to keep the authoritarian North Korean leader in check, Kim Jong-un refuses to submit.
In Europe, UK investors continue to climb the wall of worry, even though the British government is in disarray over Brexit. And what about Spain? What indeed should we make of Barcelona’s desire to be independent?
Debt markets, especially emerging-market bonds, have been shrugging off the threat of monetary tightening.
In Argentina, investors have been falling over themselves to lend the country money. Since the 1930s, the South American country has encountered economic problems roughly once every 20 years. Yet, investors are prepared to lend it money for 100 years. Its bonds were nearly three times oversubscribed.
And let’s not even get started on China’s debt mountain. Investors have pushed aside the Grey Rhinoceros that lurks menacingly in a corner of the Chinese economy.
They are crediting China for unlocking the elusive secret of perpetual economic growth. The last man to claim that he had discovered the secret of overcoming the boom-bust cycle, namely, the former Prime Minister of the UK, Gordon Brown, ended up with egg on his face.
Are investors around the world totally oblivious to the risks that lie ahead? It would certainly seem that way.
But it is not the first time that complacent investors have slept-walked into a crisis. It happened in the 1960s, when US investors were encouraged to focus on the Nifty Fifty companies that could do no wrong. These were the 50 most popular companies on the New York Stock Exchange.
The 50 are credited with propelling the market between 1960 and 1970. Investors at the time were urged to buy at any valuation and hold forever. What has happened to Polaroid and Xerox since then?
Complacency set in again at the turn of the Millennium when dot.com companies were all the rage. Investing in 2000 was synonymous with excessive speculation.
With no earnings to speak of, investors were encouraged to value companies on sales rather than profits. It was a new paradigm, we were told.
Those who could not understand the new concept were ridiculed. Those who were mocked included Warren Buffett. But many were seduced into making a quick buck in a rising market. Some even gave up their day job to become day traders.
It is happening again today.
More price-insensitive investors are ploughing money into Exchange Traded Funds. As more money is ploughed into ETFs, unsuspecting investors are forced to blindly buy stocks, regardless of their valuations.
The net effect has been to push up the valuations of the FAANGs – Facebook (NYSE: FB), Amazon (NASDAQ: AMZN), Apple (NASDAQ: AAPL), Netflix (NASDAQ: NFLX) and Alphabet (NASDAQ: GOOG), at the expenses of the rest of the market.
Thus far, ETFs have managed to survive a few market scares. This has largely been thanks to the excessive amount of central bank-generated cash that has been sloshing around global economies.
We all know about the effects of excessive liquidity. It has pushed up bond prices and dampened bond yields. It has elevated property prices and depressed rental yields. But liquidity is a quitter. When you don’t need it, it is always there. But when you do, it is nowhere to be seen.
Investor complacency has set in. But complacency is also the greatest threat to not only the markets but to our wealth, too.
In 2000, the hairs on the back of my neck stood on end when I looked at stock market valuations. In 2007, the hairs on the back of my neck stood on end when I tried to understand uncontrolled mortgage lending to people with no income, no jobs and no assets.
The hairs on the back of my neck are standing on end again today.
Never has it been more important for investors to choose their investments with care. Look for companies with little or no debt. Look for companies with positive free cash flow. Look for companies with pricing power. In other words, look for wonderful companies that you can buy at a good price.
A version of this article first appeared in the Straits Times.
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