Recently, we wrote that if confronted with the need to forecast the future, but that future is impossible to know with certainty, it is best to acknowledge you cannot know the answer, rather than fool yourself into thinking that you have the answer. Presently, most investors are very optimistic about the future, and this is reflected in high valuations for most asset classes. Markets always properly focus on the future, not the present, and the presently dismal situation certainly proves the point that markets are forward-looking creatures.
Generally, it is sound investment strategy to have an optimistic attitude toward the future because on balance, the world has been on a steady long-term trajectory of improving prosperity. That reality also incorporates periods of tremendous uncertainty, periods of loss and contraction, and a wide dispersion of outcomes for large numbers of the earth’s inhabitants. The present situation is one of global loss and contraction, leaving scars and building new muscles that may take decades to fully comprehend.
The present situation has caused governments to flood the world with money at low interest rates to subsidize the financial and economic impacts of the pandemic. The development of vaccines has provided us with a rough timeline of when we will return to a semblance of normalcy. Cheap money has found its way into assets of all types, with ever increasing projections of future returns. In short, the future looks bright because it’s so bad now, and money is abundantly cheap with few productive needs, that consequently it finds a resting place in financial assets.
Milton Friedman said,
“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
The age-old debate about inflation is raging anew. We continue to think that the inflation debate is best directed to where we see the most inflation—asset prices and not in the prices of goods and services. The world is far too competitive to raise prices aggressively, and in fact, the assets that are inflating the fastest are those that offer ‘free services’ or offer no real ‘return’ other than the hope that someone will pay a higher price in the future than they will today.
One of the most important things an investor can do is manage risk with an eye toward what stage of an investing market cycle we are in. To simplify, there are two stages of a market cycle: bull (good) and bear (bad). When in a bull market that is well advanced, the risks are high and prospective returns are lower and when we are in a bear market the opposite holds true.
At present, most asset prices are high by historical measurements, and so projected returns are likely approaching low levels. We are optimistic about the future but are also increasingly cautious that perhaps too much confidence is reflected in current asset prices. We are here should you have any questions about your portfolios or concerns about risk management and we always look forward to speaking with you!