As we watch the market’s sharp decline this week, Chadd Mason provides some timely perspective.
The big drops in stocks around the world seem scary, but in reality are a healthy part of the market’s process of buying and selling asset classes. It is important to remember that at its most basic level, money around the world is sloshing around from bucket to bucket trying to find the bucket (asset class) with the best opportunity for gain. At all times some buckets are more or less full than others. All money must go somewhere. Even if it stays in cash, that cash itself is a bucket and represents an asset class. Over the past 18 months we have seen a period of solid growth in the earnings of companies around the world. This follows a decade of anemic growth. At the same time, we have seen interest rates remain at historic lows. The reason for the low rates is that investors looking to the future weren’t sure the growth was for real and recall the awful experience of being invested in stocks in 2008. Through that lens, being invested in a “safe” bond seems ok. The result of all this is that stocks went up and bonds stayed firm, and in an unprecedented quiet fashion. In essence, we were all flying in a plane over Kansas on a sunny day without a bump for hours on end. So, what happened next? Earnings got even better! Investors realized that this new growth was going to last and if that was true, companies would need more commodities (another asset bucket) like oil, copper and aluminum to meet the growth demands. Commodity prices, of which human labor is a part, would rise. This is what is called inflation. If all of this were true, then investors would no longer be willing to tie up their money in bonds paying low interest rates. They would want to be paid higher rates or else they would move their money to another bucket. So over the past two weeks we saw interest rates rise to accommodate this new requirement of bond investors. All this change in basic supply and demand caused investors to stop and take a deep breath. This deep breath is the sell off in stocks, bonds, real estate and even commodities. Investors worldwide backed up and took their money out of all of the buckets to try and determine how much should stay in each bucket. This is healthy and good. In the end, money has to go in one of the buckets. Remember, even cash is a bucket. The cash bucket isn’t attractive if interest rates are rising along with corporate earnings. Commodities may become attractive but they don’t pay interest or dividends. So all that’s left is stocks, bonds and real estate. The same assets that did well last year! Rising rates hurt real estate due to borrowing costs, more than stocks. So, has anything really changed? In relative terms, no! Stocks are a better bucket than bonds and everything else because rates are still at historic rock bottom.
Warren Buffett, the greatest investor of all time, lost 5 billion dollars this week. This morning he probably got up early and smiled at the fabulous opportunity to put money in the stock bucket. So did a lot of other smart investors who spent much of the past year sitting in the cash bucket. The rest of us riding in the plane just crossed over into Colorado and the Rocky Mountains. The smooth ride just hit 20 minutes of turbulence after those two hours of peaceful flying. Scary? Uncomfortable? Yes, but both engines are working fine and California lies ahead.
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