Recently, we were asked: “Show I sell and go to cash? If I get out at the top of the market I won’t lose money.”
There are two sides to selling: you sell out of your existing asset to invest into what? Cash? Over time, cash will not make you more than the stock market and with inflation pressures it is likely to lose buying power which translates to losses. Cash looks safer because the dollar value you look at doesn’t fluctuate but it doesn’t grow and help you achieve your goals.
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
— Peter Lynch Author,
Valor has at times held cash after selling companies that achieved our full valuation, waiting for more obvious assets to invest in. This style of investing works when the conditions are right which is not often. It can not be the sole investment philosophy to make money over time because these events are few and far between.
Being able to confidently predict these circumstances is very difficult due to government and central banks stepping in to change normal market conditions. For example, the market stimulus of 2020 proved that waiting for these market lows with central banks willing to go much further than past corrections is like ‘Waiting for Godot’. This leads to only one conclusion, higher quality assets, which are far less affected by macroeconomics and central bank perversion are the ‘least worst’ place to allocate capital.
Where is the best place to invest?
This is decided by how you compare assets and most investors use a base interest rate of government bonds to assist in comparing returns from assets. However, the world changed in 2015, when for the first time in 8000 years, central banks set interest rates at negative levels. This fundamental shift in monetary policy changed asset prices forever. It is no longer rational to assume that zero interest rates are the lowest level to compare assets.
At a negative 0.65% interest rate level (where the Euro held rates for the last few years), shares are currently undervalued. At a 4% base interest rate level, shares are currently overpriced. There is already talk of a recession sending rates down next year.
We think that with the world’s higher debt levels over the last few decades, the impact a central bank has with interest rate rises has increased.
Smaller rate rises have a larger impact.
If we thought rates could rise to mid to high single digits, then we would be quite concerned with asset prices. But we think that the central banks won’t need to increase rates to mid single digits and that they will keep rates lower. Asset prices may remain volatile at these levels but are not overpriced.
The most important statistic to judge whether we should achieve materially higher returns than the 10 year government bond yield (currently 3.4%) is the free cash flow yield of the companies we own. This forward looking yield is above 6% and the future free cash per share growth rate should be around 11%. These metrics should provide a decent return above defensive asset returns which remain around 1-3% a year.
We remain confident that our portfolios are positioned for good or difficult times due to the quality of the companies we own. With an over 6% free cash flow yield, we are getting very good value for these exceptional businesses.