Thoughts - A New Age of Investing
Thoughts - A New Age of Investing
All signs point to a significant change in the fundamental structure of the world economy and markets. If so, here's how to protect and grow wealth in this New Age of Investing.
In the last newsletter issue, I wrote about how “This Time, It’s Different”. The claim is that the rapid de-globalization of the world (NATO vs Russia, US vs China) is driving major fundamental economic changes and existing assumptions on investing, among many other things, are quickly being nullified.
As growing geopolitical rifts close major foreign labor markets to Western economies, these economies are becoming more prone to inflation. Higher risks of inflation limits what governments and central banks can do to rescue economies while also forcing central banks to set higher interest rates.
In other words, the ever-appreciating stock market of the past decade that we’ve become so fondly accustomed to may no longer be with us.
This is the thesis of the prior newsletter issue in a nut shell. However, I forgot to answer a key question…
So what?
This newsletter issue will attempt to correct this omission and present two ways an average investor can protect and grow wealth in this New Age of Investing.
1. Alpha Over Beta
In the most recent episode of the All-In Podcast, accomplished venture investor Brad Gerstner (founder of Altimeter Capital, a venture fund with $17.9 billion in AUM) had this to say about the stock market moving forward:
“I heard somebody say this week, if the last ten years was about beta, the next ten years is about alpha. Not all companies [are] going to do well, not all companies [are] going to bounce back.”
“This is going to be about what companies have the courage to build great products and to drive a great business model that allows them to compete and continue to invest at high rates in the next wave of innovation.”
Before elaborating on this quote from Gerstner, it’s prudent to give a quick primer on market beta and alpha.
Beta
The common technical definition of beta is a measure of a portfolio’s volatility compared to a specific index or the overall market. In my opinion, this definition is confusing and non-helpful. A better and less technical definition of beta is that it simply refers to investment strategies that try to follow a specific index or the overall market. If the index or overall market is up, a beta portfolio should be up. If the index or overall market is down, a beta portfolio should be down.
Dollar-cost averaging into a low-cost S&P 500 index fund like SPY or VOO is an example of a beta investment strategy. Contributing to a 401k and keeping the money in target date retirement mutual funds is another example. Most forms of passive investing are beta strategies.
Over the past decade, beta has become exceptionally popular given the rapid and reliable appreciation of the stock market.
Alpha
Alpha, on the other hand, is how much a strategy outperforms a specific index or the overall market. An alpha strategy doesn’t try to track an index or overall market, it tries to do better by constructing portfolios that often wildly differ from an index or overall market’s composition. Investment strategies optimizing for alpha are often referred to as active investing.
For example, a portfolio overweight General Motors because the investor is bullish on Cruise’s self-driving car business is an alpha strategy. A portfolio that’s short Nvidia because the investor is worried about the US-China trade war escalating is another example of an alpha strategy.
The Next Decade Is About Alpha
Now that we’ve covered beta and alpha, let’s discuss what Gerstner meant when he said “the next ten years is about alpha”.
As mentioned above, de-globalization is ushering in higher interest rates and putting a serious check on the ever-appreciating stock market of the past decade. If this is true, how does one protect and grow wealth? Dollar-cost averaging into SPY or VOO will no longer be a reliable strategy to do so. As such, one needs to be creative to outperform the market (e.g. pick winning stocks, pick winning market sectors, or short under-performers, etc.).
Needless to say, although active investing can be immensely fruitful, it’s very hard to be successful at it and it’s certainly not for the faint of heart. In the next section, I’ll discuss a safer and more reliable non-equities strategy to safeguard wealth.
2. Don’t Ignore Bonds
In the last 13 years or so, we spent 9 of them with the Fed Funds Rate at effectively 0%. This low interest rate environment has largely knocked bonds out as a viable investment asset class for the average investor.
With the Federal Reserve actively shrinking their $9 trillion balance sheet of US government bonds and mortgages and rapidly raising the Fed Funds Rate (from 0.25% to 3.25% in the last 8 months), interest rates are soaring. This is making bonds more and more attractive to invest in.
The US 10-Year Treasury yield is now over 4%, 10-year municipal bonds (exempt from federal taxes) are yielding 3.6% (FMSbonds), investment-grade corporate bonds are yielding 5.3% (Moody's Seasoned Aaa Corporate Bond Yield) and junk corporate bonds are yielding 6.5% (Moody's Seasoned Baa Corporate Bond Yield).
In comparison, even though the annualized rate of return of the S&P 500 index since 1957 is 11.82%, the index has fallen 20% this year with much more volatility expected ahead. This makes a super-low-risk 4% yield from bonds a very attractive alternative.
Old habits and assumptions are hard to change and most people are still focused on investing in stocks and “buying the dip” but astute investors looking to protect wealth should definitely not ignore bonds!
Fin
One might disagree that recent events have significantly changed the underlying structure of markets but it’s undeniable that the world is in a period of heightened geopolitical and economic volatility.
When things are changing quickly, it pays to ask “What If?”
If one does believe that we’re undergoing de-globalization and entering a period of heightened inflation, then the two investment ideas presented in this newsletter issue, Alpha Over Beta and Don’t Ignore Bonds, should prove to be helpful.