Read these two articles: first, here’s one on Bloomberg about the U.S. economic recovery. Secondly, here’s one about the market response: not good. Why did stocks go down amidst signs that the economy is improving better than analysts expected?
The Fear of Tapering
Any value investor focuses on long-term returns because, in the short term, systemic risks will eat up profits here and there, but all of that should be smoothed out in the long term as companies’ intrinsic value overtakes the fear of big picture calamities, which are by nature short lived. Thus Warren Buffett ignores many of the technical indicators that many other analysts take as gospel: alpha, beta, and other indicators of performance, risk, and other things just aren’t as important to Warren as a company’s book value, its profitability, and the size of overall addressable markets.
This is the fundamental investor’s gospel: find value and capitalize on it. But that has not been the most profitable investment strategy, certainly not since 2008, when Federal Reserve intervention has caused low bond values and easy money to invest with.
Or so the theory goes. And it’s a popular theory. As a result, many investors suspect that the stock market is artificially inflated with cheap money that the Federal Reserve is putting into the market. This money has to go somewhere, and so it’s going in stocks, artificially inflated their prices.
For now, this is great–it creates a rise in prices that investors can profit from. In the long term, it’s a bit more worrisome–as soon as the Federal Reserve pulls the plug on the money, stocks will fall as investors deleverage.
The Paradox
Again: or so the theory goes. Whether this will actually happen or not has become a dominant theme on Wall Street, and it has caused a bizarre and historically unprecedented paradox. When news of a fully charged U.S. recovery hits the airwaves, investors smell the hint of a pullback of cheap Fed money and the future crash in stock prices. So they pull back, and stocks go down. This is what the second article on Bloomberg is talking about.
For short-term investment, this is certainly a concern; if you’ve bought recently you may be in for a shock if this tapering of cheap money comes about, rates rise, investors deleverage, and stocks go down.
For long-term value-based investment, this is no concern at all; your company holdings will grow in value over the long term, because those companies provide products and services that have real worth in the marketplace, and the margins from the sales of those products and services will come back to you in the form of capital gains and/or dividends.
And this is why fundamental, value-based investing is set for a comeback as the Federal Reserve makes a not-so quiet exit from the U.S. equity markets.