“Mr. Market” is the idea that Benjamin Graham presented in his classic book The Intelligent Investor. The idea is that Mr. Market is a hypothetical investor who is driven by emotion. Right now it seems to me that Mr. Market is fat and happy after several years of success. That has left him very comfortable.
My work tells me that is likely to be a mistake. Honestly, I think the best time to have taken advantage of Mr. Market was a few months ago, when the safe names were still cheap and nobody wanted them. That still seems like the best course of action today, given what is most likely ahead. The biggest mistake I think Mr. Market is currently making, and thus my biggest recommendation, is to avoid those very popular stocks like the FAANG stocks. To invoke another hero of finance, Peter Lynch was big on showing how over many years, earnings and price go together. How do you think that will go for the FAANG stocks? Let’s take a look at where we are today.
The direction of interest rates is a popular topic these days. The yield curve hasn’t really moved much, particularly looking at something traditional like the 2-10 spread. Mostly the whole thing has shifted up over the last month, which is causing all this talk. What’s going on, exactly? Should we panic?
No one really knows what’s going on, but I don’t see any basis to panic. I will say that volatility got really low in Treasuries, and volatility is very mean-reverting. So it’s not surprising that we are seeing a rise in volatility (I admit, I expected that rise in volatility to make yields sink as part of a greater worldwide tilt in a flight to safety.)
What do we do? There’s certainly no shortage of opinion there. Mr. Market’s opinion seems to be that this is all part of a globally synchronized recovery. To be clear, I like consensus opinions mostly because they give me something to potentially shoot against, and sometimes consensus opinions can be pretty wacky.
I think that’s the case here. Globally synchronized recovery? Where? China appears to be slowing dramatically, with no real sign of let-up. Same with the EU. Places like the US can still be claimed to be doing OK, but that doesn’t describe a recovery, but rather a lack of change. Where is this recovery? I’m much more in line with the OECD (Organization for Economic Co-operation and Development), who just cut their global growth forecast, and the IMF (International Monetary Fund) appears ready to follow suit.
Nonetheless, this isn’t the first time that people have chosen a pretty lie over an ugly truth. That seems particularly common towards the end of long bull markets. Again, what do we do in these situations? Even if things seem crazy to us, can they get crazier? Sure they can.
I like the general model of looking at what has been changing, what is likely to change, and in which direction. Another concept to consider is that you want to evaluate possible changes from multiple angles (triangulation) if at all possible, and preferably in as neutral a way as possible. To take the last part and clarify it, for instance, I think you can take parts of the recent retail, industrial, and jobs reports and create good and bad stories based on what you want to focus on in the reports. I think it’s worth noting that point, and also noting how the market interpreted the reports, so that you have an effective lens through which to effectively look at the reports.
So again, is the yield raise due to a globally synchronized recovery? Clearly I don’t think so. Then why are rates going up? Again, I don’t know, but I can come up with some reasonable ideas. EU yields have been pushing up, US short rates have been pushing up over the past year, and many people are still banging on the inflation drum despite signs that it’s rolling over. Volatility was set to increase, and the first move in rates was up – but that may not mean much in the wider scope of things. The next question is, what to do about it?
While I think looking at the 10-year Treasury is a great shortcut for judging growth expectations, there is no one-factor model that can tell you what will happen with any accuracy. Thus, it’s just one factor to look at. For that matter, there are three basic factors that tend to affect long term bond rates – growth expectations, inflation, and short-rate expectations. I think the recent move up is much more about the second two factors than the first factor.
Looking at economic data, I think it’s most fair to say that it has generally leveled off. While by itself that’s no big deal, in context it’s worrisome, because we’re shifting from growth to neutral. Growth is decelerating. When you ask the question, ‘are we getting better or worse?’, a positive answer is becoming less clear-cut. In addition, looking at the comps going forward, they are getting tougher. A lack of growth facing a higher comps bar is a tough combo.
How are people positioned? For the most part, the same way they’ve been positioned for a while. Mr. Market is positive that bond yields are going up and US tech stocks are a great place to be. In the meantime, despite the recent noise, bond yields haven’t really gone anywhere since very early in the year, and tech stock breadth has been getting worse. Thus, the expectations of the future that people are most certain of are becoming less true. There are a lot of people in those future expectations boats, and getting out at a good price could be hard.
To conclude, there is more than one way to look at market risks and rewards, and I think looking in a variety of ways is valuable, as you can see where things may align. What stands out to me? The most obvious consideration, in my mind, is that FAANG stocks and their ilk are no longer the place to be. The expectations implicit in the stocks are very high and returns are starting to flag. I’m not saying they’ll get killed, just that if you have the guts to underweight this area (and it has become a huge weighting in many indexes), that is probably the easiest way to outperform Mr. Market going forward.
Where do you want to be? Right now, that’s a little messy, as we’re likely in a transition here, and there is no strong driver. I think the odds of seeing a slowdown going forward are extremely high, though, so I’m comfortable largely being in very slow-growth areas. And so, in my mind, all of this boils down to our having a different view of the future than does Mr. Market. Mr. Market sees continued sunshine; we see some clouds forming on the horizon that we want to steer away from.