We All See It.
Asset prices are disconnected from the "real economy." Fed intervention in bond markets, not cash flow, is driving asset prices. But it's effect on the "real economy" is less obvious. Fed policy has structurally altered our capitalistic society and is directly responsible for a decade of no growth in the "real economy." We are misallocating capital.
"The task is not so much to see what no one else sees, but to think what no one else has thought about that which everyone sees."
- Arthur Schopenhauer - 1851
The current monetary system has effectively suppressed basic economics, finance, and math for the last decade. Look at the evidence we describe in our White Paper:
Negative yielding bonds from countries that are monetizing debt are "safe havens."
Debt explodes higher, but interest rates decline.
Governments can print money without causing inflation.
Massive budget deficits do not "crowd-out" private spending.
China builds 100's of "ghost cities" and yet commodity prices hit 100 year lows.
Silver prices fall to 5,000 year lows versus gold - March 18, 2020.
Failing companies can access capital cheaply.
"At a zero percent interest rate, it makes sense to flatten the Rocky Mountains to save on gas driving back and forth across Colorado"
- Paul Samuelson 1915-2009
After a bankrupt Hertz attempted to sell shares to the public, former SEC chief Harvey Pitt commented: "No one ever anticipated that people would be gullible enough to buy bankrupt stocks like Hertz." CNBC - June 16, 2020
Who are the buyers of Hertz? The holders are predominantly indexes and trend-following quantitative funds.
"According to estimates by JP Morgan, passive investments now control about 60% of the equity assets, while quantitative funds – those relying on trend-following models instead of fundamental research – now account for approximately 20% of the market share." CNBC - June 29, 2019
This means that about 80% of the US equity market is driven by investors who do not look at the individual stocks in their portfolios.
Notice that passive investing exploded higher after the global financial crisis at the exact same time that the Fed's direct quantitative easing - unprecedented in US history - increased the monetary base nearly eight-fold. Massive liquidity was used to manipulate interest rates and temporarily suspend basic economics, finance and math. Markets shifted from active (rational) to passive and trend following quantitative funds. The stock market is now a de facto policy tool of the Fed.
If you are holding index funds, then stop asking who are the investors making these decisions - just look in the mirror! The passive index that you are entrusting with your money has no idea that Hertz went bankrupt. But you know!
The fact that passive indexes have beaten actively managed portfolios over the past 10 years is not evidence that markets are efficient. Instead, it is evidence that the unprecedented scale and duration of Fed intervention in capital markets created moral hazard (Fed put), encouraged speculation, misallocated capital, structurally altered our capitalistic society and slowed the "real economy."
This was a period when markets became inefficient. Look at the evidence that we discuss in our White Paper:
The post-2008 recovery was the weakest in US history: GDP 2.2%/year, Productivity 1.1%/year.
"Zombie" companies may soon represent 20% of U.S. firms. Axios - June 15, 2020
Revenue growth matters more than profitability.
Company management teams that efficiently allocate capital under-perform profitless "disruptors."
Passive investments control 60% of assets versus 22% in 2007.
Companies that dilute shareholders are rewarded with higher stock prices.
Accounting shifted from GAAP to non-GAAP "fiction".
“If everybody indexed, the only word you could use is chaos, catastrophe… the markets would fail.” - Jack Bogle, founder of Vanguard 5/6/17 - Bloomberg
Our markets are failing. We are at a major inflection in world history and capital markets.The excesses have been compounded by the evidence that capitalism now disproportionately benefits the top 10%, who can access the "wealth effect" thru inflated asset prices, compared to the bottom 90%, who rely on the "real economy" to grow wealth.
The true track record from the period should be measured not by the wealth effect that drove asset prices, but by its effects on the real economy. Wealth effects are temporary. Only productivity growth creates long term sustainable wealth.
The analysis in the following pages supports my thesis that the financial system is set to be drastically altered as the $340 Trillion Problem resolves itself in the coming years.
We expect a paradigm shift from a strong dollar with no inflation to a weak dollar with inflation, which will re-order markets, return asset prices to their intrinsic values, and allow the real economy to start growing again. Be on the right side of history. Buckle up! Things are about to change!
Investor checklist:
If you answered "no" to all three questions, then our investing philosophies are aligned. The catalyst is inflation. Negative interest rates are a major sign of an extreme market distortion and investing is forward looking.
Focused Capital LLC was founded on the sincere belief that asset prices are disconnected from their bottom-up intrinsic values. After managing the Fidelity Focused Large Cap Growth fund and other related assets, which grew from $20 million to more than $7 billion over a decade, the time was right for a more flexible mandate to express our commitment to this thesis. The "real economy" will need an experienced, independent, and credible voice from an investment professional with character in the upcoming debate.
There is no equivalent "moral hazard" here. My investment will be alongside yours. It's not corporate. My email and personal cell are below. So, if you agree that things do not make sense and you are an intrinsic value, bottom-up investor, then you should invest alongside me.
Chris Galizio - Portfolio Manager, Focused Capital LLC
Cell: (508) 808-1483
Feel free to text me with questions or set up a time to meet or Zoom.
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