A Time To Be Fearful?

Warren Buffett has famously said that he likes to be “fearful when others are greedy and greedy when others are fearful.” How are most investors feeling today?

Stock markets have been on a tear! Aside from the dramatic yet short-term drop in March 2020, the last decade has been wonderful for investors. From its low in March 2009, the S&P is up five-fold. Even though Canadian stocks have not done quite well, investors here have also been rewarded over the last decade.

Bond investors have also done well as interest rates have generally continued their falling trend that’s been in place since the early 1980s. As Buffett has stated, interest rates act like gravity on asset values, so as rates fall, asset values rise (housing, stocks, bonds).

Right now, everyone feels like an investing genius. We’ve all been getting rich despite the pandemic. There is a very cheery outlook right now that once vaccinations are all finished, we can all look forward to a rip-roaring economy. Initial Public Offerings (IPOs) (new companies hitting the markets) are at record highs. U.S. margin debt (where people borrow to buy stocks) is hitting new highs as well. Speculative investments such as Bitcoin and Tesla are making speculators rich! New platforms such as Robinhood allow investors to trade commission-free. Some new participants in the market follow online chat rooms where crowds of speculators pile into various stocks such as Gamestop and drive the stock price up into the stratosphere.

With this backdrop, I am becoming a bit more fearful. My approach has been pretty simple—buy quality stocks that pay dividends and then sit on my ass(ets) and do nothing and collect ever-rising payouts. Yes, there are investors who can discover the next hot stock or see where certain industries are going and invest there—but I am not smart enough to do that. My strength has been in knowing my limitations and not trying to venture into areas I don’t really understand. I will invest in potato chips over computer chips or soft drinks over software any day of the week, which is why one of my holdings is Pepsico. This simple approach has served me well over time, so I am reluctant to change.

However, my approach of looking for “low-risk returns” is coming up empty-handed more often these days. In the era of near-zero interest rates with most investors seeing only sunshine and lollipops as far as the eye can see, there just seems to be more “low-return risk” opportunities in the stock market these days. As such, I have been becoming more conservative.

For most of my investing life, I have had a very simple investment approach. Buy quality, dividend-paying companies trading at reasonable prices whenever I had the money to invest. Almost the entire time, aside from a small amount of cash set aside for basic living, it has been 100% stocks all the time. It has served me well over the years.

But stock valuations are quite high today. For example, Visa has been my best holding over the last decade and has returned around 900% over that time. This mirrors (to an extent) the experience of investors in Coca-Cola from 1988-1998 where the stock rose almost 20-fold. But, at its peak in 1998, Coke traded for a P/E ratio of over 50 with a projected earnings growth of around 13%. And how did things turn out? From a share price of around $43/share in 1998 the stock price crashed by over 50% a few years later. Buy and hold investors who simply held on saw the stock price grow to around $50-ish today (a 16% gain in 23 years or less than 1%/year return, excluding dividends). Today, Visa trades around a 50 P/E with projected earnings around 15% (so not quite, but almost as expensive as Coke in 1998.) I see the company continuing to do well, but I don’t think investors buying today will capture a large share of that performance. In other words, the price you pay still matters.

Traditional pension plans have often followed a 60/40 approach where 60% of their assets were in stocks and 40% in bonds to de-risk the portfolio to an extent. But with bonds trading at near-zero interest rates, bonds offer a lot of risk for very little return (as bond prices fall when interest rates rise), so forget that. I have sold some of my highly valued holdings and used the money to buy a few defensive value stocks. I have also raised my cash position to around 40% of my portfolio overall. I have added a few gold stocks (streamers not miners) and put a little into preferred shares. From where we are today, future returns will be lower in aggregate than they have been in the past. Some investors might be able to choose winning stocks that do really well from here, but valuations are a handicap they will have to overcome. Not being too smart, I’ll focus on lowering my risks.

Derek Foster (Six-time National Bestselling Author)

www.stopworking.ca