Opportunity Costs
Our periodic communication that reminds you to ask, “Should I react to those headlines?”
June 2024
Opportunity Costs
“A bird in the hand is worth two in the bush"
- Old prover
For the preservation allocation, we use financial instruments with a “Preservation” objective such as money markets, CDs, and U.S. Treasuries with durations shorter than five years. These instruments are subject to wide fluctuations in yield, interest rate, or income from “parking” your money there. In other words, all financial instruments have risks. As they say, there is no free lunch. Two key differentiators between these instruments and stocks are how they “exit” or “mature” and who is promising that payment.
Due to the Federal Reserve’s current strategy to fight inflation, short-term interest rates are over 5%. The market's belief that the Fed will win the inflation fight has resulted in long-term rates of around 4% . Usually, long-term rates exceed short-term rates. Let’s dive into what could be causing this anomaly.
Are there no more skeptics?
Recently, I read an article where the Bond King, Bill Gross, labeled the investment strategy that made him famous and rich, “total return,” as dead. He began this strategy around 1982 at the peak of a long and steady drop in interest rates. As interest rates fall, bond prices rise. This “wind” at the back of the bond market allowed him to achieve capital appreciation along with income from bond investing, hence the term “total return.”
It seems there is a tad bit of skepticism in Bill’s thoughts.
Is the market not functioning efficiently and pricing items effectively?
I believe this would be the larger shock to the wider market participants.
Some points to consider:
- Inverted yield curve: This could indicate that the market trusts the “power of the Federal Reserve” more than it should, relying on the Fed's words and intentions rather than the data.
- Large amount of capital indexing: Significant capital has been invested into index funds, promising similar historical returns as “stocks” without the trouble of “thinking” for a very low fee. This has left some large important capital decisions in the hands of a few people, potentially causing less than efficient transactions in the marketplace.
- High home prices but low turnover: Increased mortgage rates have led to fewer houses trading hands rather than a housing crisis or price pullback. This has caused a housing shortage as home builders, cautious after the last crash, have not been as willing to invest in new developments.
- Slowness in parts of job markets: With notable exceptions like artificial intelligence jobs, the post-pandemic job market sees fewer employees risking job changes, leading to inefficiencies as people fear seeking improvement in their lives.
- Private equity and private lending more prevalent than going public: More companies find resources available before going public, often due to the costs of being a public corporation, signaling less efficient markets.
- Crypto currencies drawing speculators: With unclear regulation, cryptocurrencies like Bitcoin continue to attract speculators, indicating a mistrust of government economic figures and less efficient markets.
- Bear funds have been shut down: Fewer funds that short the markets exist today, reducing a check on companies’ management.
- International returns are relatively low: Capital leaving for the U.S. can cause inefficiencies in other markets, where companies may perform poorly due to a lack of investment.
- Micro Cap public companies: This sector receives less funding and attention, with money flowing into large cap and private companies, causing some small public companies to underperform.
If these “shocks” are semi-true, participants responsible for resource allocation decisions could be suffering from the perfect storm of:
- “It doesn’t matter.”
- “I am afraid to.”
- “I am confused.”
- “Let others do the hard work.”
What should investors consider?
- Consider risk first: Markets are cyclical. My contrarian ways lean toward more economic and price volatility ahead than what the market seems to be pricing in. Avoid joining the crowd if you don’t understand what it entails.
- Consider general market inefficiencies: Our markets are the envy of the world, functioning well because enough people avoid acting as if “it doesn’t matter,” “it’s too confusing,” “it’s too scary,” or “others will do the hard work.”
- Consider Opportunity Costs: Opportunities lie where the lazy, the fearful, the uninformed, the unthoughtful, and the impatient won’t go.
Could our “wide separation” be not so wide?
At a time when interest rates were near zero and the Dow Jones was at 10,000, the line between “investments” and “preservation” seemed wider. With short-term rates at 5% and the Dow Jones at 40,000, the line seems to have narrowed. Two recent quotes may help the perspective that “preservation” can be a good “investment”:
Charlie Munger: “It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait.”
Bob Robotti: “It is difficult to maintain patience when managing other people’s money.... The decision to remain patient is an active decision, no less important than buying or selling a security.”
The challenge is to maintain perspective and seize opportunities without falling into speculation and gambling. This is an ideal task not mastered by any human.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Advisor.Investments [“AI”]), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from AI. Please remember that if you are a AI client, it remains your responsibility to advise AI, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. AI is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the AI’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request.
Please Note: AI does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to AI’s web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
