Fully Invested
The market gets so overvalued that expected 10-year returns from stocks can fall to zero or even negative. We’re in one of these rare moments now. In these moments, gold seems to do especially well.
Chiswick, West London
Wednesday, October 9
By Tom Dyson, Investment Director
QUESTION: I’d be interested to get your thoughts on this chart…
MY RESPONSE: There’s no better way to grow wealth than by investing in
long term in well-run, capital efficient businesses. You just can’t beat the compounding power of reinvested profits in a business with great long term returns. It’s almost like magic. So that’s the default position I want to occupy. Fully invested in stocks.
Occasionally, the market gets so overvalued that expected 10-year returns from stocks can fall to zero or even negative. We’re in one of these rare moments now. In these moments, gold seems to do especially well. So that’s the strategy in a nutshell. Its core is a simple market timing strategy switching between gold and stocks.
By holding gold for a few years, we’re betting we’ll be able to eventually multiply our purchasing power in the stock market. Both the Dow and S&P 500 made new all-time highs today. We know valuations can remain elevated (irrationally) for extended periods of time. We also know it's worth waiting for the right price to be fully invested again. We’ll see.
In the last month, there’s been a big rally across the commodity complex (and a small correction). The chart below shows the Bloomberg Commodity Index. The index is made up of 24 commodities across six sectors: Energy, Grains, Softs, Industrial Metals, Precious Metals, and Livestock. Sectors are restricted to a maximum weight of 33% and each individual commodity is restricted to a maximum weight of 15%.
It makes me wonder, is inflation about to make a comeback? CPI comes out tomorrow. But check out this new way of measuring purchasing power, from Primerica, the giant life insurance company...
Primerica released a new index that measures the purchasing power of middle class families for expenses like food, gas, utilities, and health care. It shows a big loss in purchasing power from 2020 to 2022, roughly the same time as 20% expansion in the money supply (and the total price level). Since then, the Household Budget Index (HBI), purports to show the middle class financial comfort levels returning to where they were in 2019.
What do YOU think? Has middle class purchasing power been rising or falling in the last two years? Leave your comment below…
Here’s another market signal I’ve been watching closely: the long term interest rate. The chart below shows the interest rate on the 30-year Treasury bond.
The Fed just cut short-term interest rates by 0.5%. All else equal, long term interest rates should have fallen too. Instead, long-term rates have been rising, like commodities.
It could be nothing. Or could it be a sign that the Fed is losing control of the bond market? That's the important question of last week. The Fed cut rates… and long-term bond yields rose.
That tells you — or at least it could — that the market (especially long-term and fixed income investors) are a LOT more worried about inflation than the Fed, and the fact that government deficits are out of control.
What if commodities and bond yields keep rising? How will other markets react?
Our strategy is simple. We don’t know how this is going to play out, so we’re hedging our bets. We know it should result in higher inflation, but not in a straight line (inflation volatility). What we don't know is when the mean-reverting corrections in stock prices will occur. We DO know that Dow/Gold will tell us when stocks are cheap again.
In case the Fed has to go back to fighting inflation again, we’re holding a bunch of cash. Cash hedges us against falling nominal prices, which are surely what we’ll see if the Fed has to make a policy U-turn.
Cash represents 35% of our asset allocation.
In case inflation surges again, and the Fed doesn’t challenge it, we’re holding a big pile of hard assets. Gold, silver, platinum, bitcoin, uranium, energy and shipping represent 65% of our assets.
This hedged portfolio should keep us safe in deflation, inflationary boom or stagflation environments, and generate a little income on the side.