<December 29, 2020>
The office retailer, Staples, introduced the “Easy Button” in a 2005 Super Bowl ad. Starring in the commercial was a student taking an exam, a father changing diapers, and a surgeon performing surgery—all difficult tasks. Instead of completing these tasks, each individual pressed the red Staples’ Easy Button. The commercial ended with, "Wouldn't it be nice if there was an easy button for life?"
I was reminded of Staples’ Easy Button after a recent conversation with a portfolio manager. We periodically talk about the markets, stock ideas, and our families. We’re good friends. And as a friend, I wanted to make sure he was fine with me sharing our conversation, and he was.
Our conversation began by rehashing our frustrations with equity valuations and the difficulty finding genuine discounts to value. We also vented about the Federal Reserve and its ongoing interference in the financial markets. As patient value investors, our jobs have been anything but easy. However, on this day my friend seemed a little more at peace with the current investment environment.
After discussing his positioning, I was surprised to learn he had tilted towards growth stocks and was more fully invested. He acknowledged the move was a departure from his previous way of investing, but explained his rationale. “Look,” he said, “we know what’s going on. The Fed isn’t going away. They’re going to keep printing money until they’re blue in the face. They’re trapped and can’t let asset prices fall. I might as well ride the wave of asset inflation and keep up with everyone else.”
He then explained how it feels to be on the other side of the style boxes. “Holding growth stocks,” he said, “has a much different feel than owning value stocks.” “How so?” I asked. “Well, think about all the times you’ve held a beaten-down value stock.” I replied, “Yes, I’ve owned a few of those!” He continued, “Then you know that dreadful feeling before they report earnings. You can’t sleep the night before because you know earnings are going to be weak and the stock is going to fall.” I acknowledged, “Yep, every value investor has been there.” He went on, “Well, with growth stocks, it’s the exact opposite. The night before earnings I open a bottle of champagne and celebrate how much money I’m going to make the next day. It’s a wonderful feeling!”
Instead of lecturing him on the importance of discipline, I told him I understood. In the current environment, professional managers either have to try to keep up and save their jobs or fight the Fed and run the risk of getting run over by their peers. And to his credit, he’s been right since he made the transition and his performance has improved.
Given the sharp rise in growth stocks YTD, combined with below average cash levels in managed funds, it appears my friend isn’t alone. As active managers fight for survival, taking on more risk and reducing cash has become increasingly common. A recent Bloomberg article noted that fund managers are the most bullish on risk assets since 2011 and are the most underweight cash since 2013. Data from ICI also shows mutual fund cash levels have declined to all-time lows. As equity prices and valuations reach record highs, portfolio managers are having to make the difficult decision on whether to maintain their discipline or capitulate and follow the herd.
As the technology and housing bubbles illustrated, there are significant risks associated with capitulating on discipline and chasing performance. While it’s easy to criticize portfolio managers for assuming these risks, refusing to follow the crowd is not as easy as it sounds. Many of the professional managers I know are not too dissimilar than most Americans. They have mortgages, future obligations, and families. It’s not as simple as buying low and selling high. Although this doesn’t excuse managers from their professional responsibilities, it helps shed light on why so many sophisticated investors succumb to the late-cycle pressure to keep up with rising markets. With prices and valuations reaching extremes, we believe it’s never been more difficult to stay the course and maintain discipline.
To help professional managers allay their fears about overpaying and abandoning their discipline, policy makers have become increasingly supportive. On December 16th, Chairman Powell essentially gave investors the green light to pay current valuations, stating high P/E ratios are less relevant today than in the past. Instead of removing the punch bowl as the party gets out of hand, the Chairman is encouraging partygoers to consume even more!
The Federal Reserve has also encouraged Congress to keep the punch bowl flowing, stating fiscal and monetary policy should work “side by side.” Whether its forgiving student loans, spending on infrastructure, or funding future stimulus, the Federal Reserve has made it clear that its expanding balance sheet will be there to pick up the tab.
As the Staples’ commercial asks, “Wouldn’t it be nice if there was an easy button for life?” Apparently, when it comes to fiscal policy, investing, and money creation, there is—it’s called the Fed Easy Button!
If you believe the Fed’s “Easy Button” seems too good to be true, we believe you are right. Monetizing and forgiving debt can reduce the incentive to save and destabilize currencies. Relentless asset inflation also has consequences, including discouraging due diligence, promoting financial instability, and increasing wealth inequality. And what about our unchecked and growing fiscal deficits? It increases dependence, reduces productivity, and is an irresponsible example to set for our younger generations. How can we lecture our children about the virtues of hard work and sacrifice when we’ve convinced ourselves that we’re entitled to endless and effortless money creation?
With trillions of dollars having already been created and spent, there may be trillions more on the way. As such, we understand why so many portfolio managers would rather assume the risk of an asset bubble than the risk of being left behind. That said, regardless of the pressure to keep up, we have not abandoned our belief that price is the most important variable in determining the success of an investment. Therefore, based on the price of our opportunity set, we are currently much more concerned about risk to capital than chasing near-term performance. In summary, we remain steadfast in our refusal to overpay and become dependent on the Fed’s Easy Button.
Successful investing is not supposed to be as easy as pressing a button. And it certainly is not supposed to be as “easy” as it is today. Instead of extrapolating current trends, we believe the day is approaching when central banks lose their ability to create money without effort or sacrifice. Whether their failure to maintain control begins in the bond or currency markets, we don’t know, but believe that day is getting closer and closer. And when it comes, we expect investors and policy makers will panic. They will press the Fed Easy Button and it will not light up, there will not be a response, and the Fed’s once dependable bid will disappear. While the Fed’s bid may not be there, we expect ours will be—helping those who feared missing out, to get out, at much lower prices.
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Definitions:
Wilshire 5000: a market-capitalization-weighted index of the market value of all US-stocks actively traded in the United States.
Price to earnings ratio (P/E): Stock price divided by earnings per share.