We hope you are doing well. We look forward to seeing all of you in person once it is safe to do so. In the meantime, it is business as usual at APEX – know that we are here for you and just a phone call away.
Before we get to our investment update, we wanted to thank you for your patience and patronage over the past year. It has been a rough year! Sincerely, thank you for continuing to entrust us with your investments and allowing us to serve you.
In this letter, we begin with some thoughts on the markets.
One of the great advantages of experience, in investing and in life, is perspective and better judgement. In picking stocks and other investments, your judgement gets better with study, practice, and long experience. Knowledge is one thing, wisdom another. Knowledge is easily acquired, wisdom is hard-earned. Experience incorporates lessons learned from mistakes. Like Howard Marks says, “Experience is what you get when you didn’t get what you wanted”. Experience also teaches investor psychology and the nature of markets. So, what does our experience tell us about today’s markets?
First, the mood of the market is quite bullish; investors are generally complacent about risk and certain “narratives” are underpinning high valuations. Some sectors of the market look downright bubbly, to be frank.
Narratives, or stories, can have a big impact on markets. That is the theme of the great economist Robert Shiller’s latest book, Narrative Economics: How Stories Go Viral and Drive Major Economic Events. The gist of Shiller’s book is that “popular narratives — simple stories, true and untrue — influence booms, recessions, and other economic events” and that “economic events are substantially driven by contagious spread of oversimplified and easily transmitted [stories]”. We read this book in 2019 on a beach in Antigua……sigh!
So, what narratives are at work in today’s markets? One is that high stock valuations are justified by low interest rates. We agree but counter that low rates do not justify any price. And what if rates normalize?
Oaktree’s Howard Marks has similar questions. This, from his April 2021 Letter to Investors:
“The Fed says rates will be low for years to come, but are there limitations on its ability to make that happen? Can the Fed keep rates artificially low forever? On longer-maturity bonds? And what about inflation? Can the 10-year Treasury note still yield 1.40% if inflation reaches 3%? Will people buy it at a negative real yield?”
Another story is that post-pandemic and a sharp correction, the U.S. and Canada are set for another long-term economic expansion like the 1920’s (the “Roaring Twenties”). Our take: no one knows. And with starting valuations being quite high, prospective returns over the next decade are likely to be below the long-term average.
It is also notable that Western Governments are possibly testing the limits of borrowing capacity; austerity and fiscal discipline have fallen out of favour. Can the Canadian and U.S. Governments continue to run large deficits (i.e. borrow) with impunity? A lot could go wrong and derail the “Roaring Twenties” narrative.
Yet another popular narrative is that Bitcoin and other cryptocurrencies are an asset class, like stocks and bonds, and therefore deserve a certain weighting in your portfolio. It is not yet clear whether cryptocurrencies are a legitimate investment, a potential store of value or possibly a currency (which of these depends on who you ask) or maybe none of the above. You may have heard of dogecoin – a cryptocurrency based on an internet “meme” featuring the face a Shiba Inu dog. It was created as satire; an internet joke / meme. Today, dogecoin has a market capitalization of $36 billion. Bitcoin has a market capitalization that exceeds $1 trillion. You see crazy things in markets.
Some say that the huge runup in price for these “coins” is evidence of a bubble, while backers remain fervent believers. An open question for cryptocurrency bulls: how do you come up with an estimate of value? And why can’t bitcoin (now, at ~ $67,000 CAD) trade at, say, $50, or $0? From our vantage point, there is nothing tangible to support or justify the price. And just because there is a limited number in circulation is not good enough – Beanie Boo stuffed animals were also in limited supply.
Our take on cryptocurrencies, generally, is that they are non-productive assets (i.e. they do not produce an income stream), so their value is very much in the eye of the beholder. So if they are to be considered as investments, then they are not investments that we covet. Their utility as a currency or a form of payment is highly uncertain. What kind of currency fluctuates wildly in price? Dogecoin spiked 400% over the 7-day period ended April 16th and subsequently lost 40% of its value over the ensuing weekend. As we write, Bitcoin dropped 8% over a 24-hour period ended April 23, 2021. And if they are to be considered as currency, how do we square that with the promoters’ forecasts of ever-higher prices by supporters? Currencies, like our dollar are not an investment – their unit value is constant (but subject to depreciation). You cannot have it both ways.
The biggest obstacle, of course, is that Governments need to control currencies as part of a stable monetary system. Federal Reserve Chairman Jerome Powell recently shared his views on BTC and other crypto currencies: cryptocurrencies are “highly volatile and therefore not really useful stores of value and they’re not backed by anything”.
There is a possibility that Governments may issue digital currencies, if they were to deem it advantageous (but most transactions are already electronic and seamless, no?). In fact, there is an existing cryptocurrency whose value is pegged to the US dollar, USD Coin (USDC). In China, the state has issued digital renminbi.
In any event, it is speculation as to whether cryptocurrencies prove to have some form of utility or investment value. At the risk of being labeled as cynics, you can put us down as skeptical. In our view, many of today’s cryptocurrency investors are banking on a greater fool to buy at higher prices. This is a treacherous game. It may not end well.
But it is a good story that includes shiny new technology and taps into mistrust, on the part of some, in Government-backed currencies. Shiller explains that “Part of the reason that Bitcoin succeeded is that it fed into an anarchism narrative that government is unnecessary and untrustworthy. It fostered a narrative that young people have created a financial institution that is out of the government’s reach”.
Buffett once said, about “fermenting” or, emerging industries, “it’s like space travel – we applaud the effort but prefer to skip the ride”. This aptly describes our thoughts on cryptocurrencies. We make no excuses for being discriminating – good investors think independently and say “no” to most things. If you want average results, simply do whatever the crowd is doing.
The stunning increase in price of Bitcoin and like investments does tell us something, however, about the state of markets. With millions of brokerage accounts being opened by retail investors and the gamification of investing (spend some time on social media for evidence of this), we worry that a new generation of investors may be exposed to heightened risk. Sometimes it takes a generation or so for old lessons to be forgotten and learned anew.
We don’t profess to know whether Bitcoin will be a good “investment” and we don’t waste our time on such pursuits. We take our cue from history’s greatest investors, many of whom do not try to predict the unknowable. Our experience is that in investing, simplicity trumps complexity. As the proverb says, “Beware of the door that has too many keys.”
In our view, a good investment must pass through some very basic filters. These filters are a product of experience over several market cycles. Following is the strategy, brilliant in its simplicity, of the very successful U.K. fund manager Terry Smith (Fundsmith LLP):
Only invest in good companies. Don’t overpay. Do nothing.
“…what I have observed about the really great investors is the simple decisions that they end up having to make by virtue of focusing on what’s important and what’s unknowable.” -Tom Russo, Semper Vic Partners
Some of these stories that we have discussed may actually come to pass, but our point is that viral narratives that are widely accepted as true can lead to undue optimism and possibly overvaluation. Our experience is that narratives can work to feed booms in markets. After all, the longer that an asset appreciates, the more conviction that people develop about its soundness and its prospects. Narratives contribute to herding, FOMO, and other emotional biases. Many popular narratives become treacherous as investments, owing to their popularity – buying begets rising prices, which begets more buying, which begets FOMO, which begets buying, etc. The pendulum of investor psychology swings toward greed; euphoria. At this end of the spectrum of fear v. greed, “everyone wants to buy, no one wants to sell, and few people can think of reasons why prices shouldn’t rise” explains Howard Marks. What becomes popular can become overpriced. The electric vehicle space may be experiencing this type of self-reinforcing circle of momentum.
Men, it has been well said, think in herds. It will be seen that they go mad in herds, while they only recover their senses slowly, and one by one. – Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds
The fund manager Bill Miller once said that “great investors are not unemotional but are inversely emotional – they get worried when the market is up and feel good when everyone is worried”. So, whereas more and more investors buy into bullish narratives and valuations become more stretched we see cause for worry.
In a recent Financial Post article, the economist David Rosenberg shared similar cautious sentiments:
“It is fanciful to believe that we will come out of the first global pandemic in more than a century into a world of newfound sustainable inflation [i.e. growth]. Or that a massive surge in public-sector deficits and debts, producing little more than a short-term sugar high, have assured us an economic future replete with the Roaring Twenties and “Goldilocks” economic scenario”.
Rosenberg is also feeling the inverse emotion of worry. He cites Bob Farrell, a market analyst for several decades at Merrill Lynch. Farrell is known for his “10 Rules for Investing”, a collection of adages / observations that are steeped in wisdom. In this FP article, Rosenberg invokes Rule # 9, “When all the experts and forecasts agree — something else is going to happen” to explain his sentiments about the economy. Our experience can attest that the consensus view is often wrong or overpriced.
Rosenberg sees bubbles in residential real estate and equities but concedes that “excesses will always go further than you think (where we are now) and that no bubble ever corrected by going sideways” (Farrell’s Rule #4). He concludes that “the market consensus is so overwhelmingly one-sided that I don’t find it one bit difficult to bet in the other direction”.
Perhaps the most important decision that we make with you is where to position on the continuum of aggressiveness v. bullishness. A lot is riding on this decision over your investment time horizon. There can be a large swing, in terms of the terminal value of your estate or, alternatively how long your investments are able to sustain a comfortable level of withdrawals, depending on the quality of these decisions.
Most of the time it is a mistake to bet against the market. The level of business conducted in Canada and the U.S. has and will continue to go up over time. Businesses will retain capital and grow, and inflation will also work to increase revenues. Innovation and human ingenuity will continue to create new ideas, new businesses, and greater prosperity for all. So, in the long run it is to your advantage to be in stocks. Buffett touched on this in his 2020 Chairman’s Letter:
“Ownership of stocks is very much a “positive-sum” game. Indeed, a patient and level-headed monkey, who constructs a portfolio by throwing 50 darts at a board listing all of the S&P 500, will – over time – enjoy dividends and capital gains, just as long as it never gets tempted to make changes in its original “selections [emphasis, ours].”
Notice the qualifier about tinkering? That is experience / wisdom talking. And not everyone is “patient and level-headed” when it comes to investing. Advantage: monkey.
As we have stated previously, there is also a very real risk of not being invested in stocks (i.e. opportunity cost and the potential ravages of inflation) that we must consider. So, it is a challenge to balance the need to be invested in stocks with the need to protect capital in a world where most everything looks fully priced or expensive. Many of you are in the “de-cumulation phase” of life, so sidestepping big mistakes is “job one”. We take our stewardship role very seriously.
The best way, in our view, to move forward is to buy and hold quality (i.e. wide-moat) stocks but be defensive / cautious; be discriminating. The investment environment could look a lot different in a year or two – opportunities will present themselves and we should be prepared to act.
Howard Marks has similar sentiments. Oaktree’s current strategy is to “move forward with caution”. In his most recent letter to clients he lists several causes for worry including:
1. The actions of the Fed and U.S. Treasury may be leading investors to aggressively pursue high returns in today’s low-return world, replacing risk aversion with risk tolerance.
2. Signs that in the past indicated excessive optimism and complacency in stock and bond markets are present today:
(a) the strong performance of speculative securities and “meme” stocks;
(b) heavy retail buying of stocks, options buying, and buying on margin;
c) heated bidding for bond deals, low bond yields and weak contractual protections;
d) the Buffett Indicator (the ratio of total equity market capitalization to GDP) far above its previous high; and
e) large numbers of IPOs, including IPOs by unprofitable companies, and first-day share price jumps of tens or hundreds of percent.
3. A long-term worry that may seem theoretical and far off, but I think are potentially significant:
Can the Fed really increase its balance sheet by trillions of dollars and the U.S. run annual deficits in the trillions – in 2020 and in coming years – without negative consequences, like a decline in the dollar’s value? If the dollar performs poorly, will it remain the world’s reserve currency and leave unchanged the U.S.’s ability to borrow unlimited amounts of money to cover deficits? And what happens if the answer to that last question proves to be “no”?
But Marks points out that the high valuation of today’s S&P500 must be taken in the context of low interest rates and “the shift in its composition in favor of rapidly growing technology companies, with their higher valuations”. In past letters to you we have noted these same caveats. He concludes as follows:
“So where does that leave us? In many ways, we’re back to the investment environment we faced in the years immediately prior to 2020: an uncertain world, offering the lowest prospective returns we’ve ever seen, with asset prices that are at least full to high, and with people engaging in pro-risk behavior in search of better returns. This suggests we should return to Oaktree’s pre-Covid-19 mantra: move forward, but with caution [emphasis, ours]”.
In closing, our strategy remains to “move forward with caution”; to remain invested in high quality stocks; think long-term and be “inversely emotional”. As always, our priority is to protect your capital. We will gladly accept a walk rather than swing at bad pitches.
Best wishes to you and your family from your Apex team: Shawn, Scott, Mike, John, Will, Denise E., Jason, Denise N., Lisa, Marta, Darlene, Paula, Jeff, and Greg.
The information contained herein was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. This report is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell any securities mentioned. The views expressed are those of the author and not necessarily those of ACPI.
Aligned Capital Partners Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.
 “Robert Shiller on the Power of Narratives”, Yale News, Mike Cummings, November 4, 2019, https://news.yale.edu/2019/11/04/robert-shiller-power-narratives
 “2020 in Review”, Howard Marks, Oaktree Capital Management LLC, April 2021, https://www.oaktreecapital.com/insights/howard-marks-memos
 Yahoo Finance, https://ca.finance.yahoo.com/quote/BTC-CAD/?p=BTC-CAD
 “Bitcoin tumbles from recent high as cryptocurrencies take weekend hit”, CNBC, Tom Huddleston Jr., April 18, 2021, https://www.cnbc.com/2021/04/18/bitcoin-plunges-from-recent-high-as-cryptocurrencies-take-weekend-hit.html
 “Over $200 billion wiped off cryptocurrency market in a day as bitcoin plunges below $50,000”, CNBC, Arjun Kharpal and Ryan Browne, April 23, 2021, https://www.cnbc.com/2021/04/23/bitcoin-btc-price-plunges-as-260-billion-wiped-off-cryptocurrencies.html
 “Fed’s Jerome Powell: Public should understand risks of Bitcoin”, Business Standard, Associated Press, March 23, 2021, https://www.business-standard.com/article/markets/fed-s-jerome-powell-public-should-understand-risks-of-bitcoin-121032201478_1.html
 “Robert Shiller on the Power of Narratives”, Yale News, Mike Cummings, November 4, 2019, https://news.yale.edu/2019/11/04/robert-shiller-power-narratives
 Berkshire Hathaway Chairman’s Letter 1996, Warren Buffett, https://www.berkshirehathaway.com/letters/1996.html
 “The Happy Medium”, Howard Marks, Oaktree Capital LLC, July 21, 2004, https://www.oaktreecapital.com/docs/default-source/memos/2004-07-21-the-happy-medium.pdf?sfvrsn=2
 “David Rosenberg: I haven’t been this excited about going against the herd in years”, Financial Post, David Rosenberg, April 14, 2021, https://financialpost.com/investing/david-rosenberg-i-havent-been-this-excited-about-going-against-the-herd-in-years