In 1978, while sipping Caipirinhas in a bar, on a hot and steamy Rio de Janeiro evening, Barry Manilow was inspired to write an upbeat yet very dark ditty, set in the “hottest spot North of Havana”. Everyone knows the story of Lola and Tony, and the love that grew while she danced, and he served drinks. No self-respecting karaoke night is complete, without at least one drunken rendition of the legendary “Copacabana”. Who knew that Barry was a financial guru, and his song would be able to provide us with so much insight on the markets and investing today.
Her name was TINA, she was a showgirl …
In 2021, we regularly use acronyms such as FOMO (Fear of Missing Out) and TINA (There Is No Alternative), which are words we have created in our lexicon, to explain and justify our risk-taking behaviors. However, if we pause and reflect, actions and behaviors which are motivated solely by FOMO and TINA should set off alarm bells, and give us reason for concern.
His name was Rico, he wore a diamond …
Public equity markets continue their march upwards in the first quarter of 2021. Market strength is affected by so many different factors. Improving Covid-19 vaccination rates in the general population has led to positive outlooks. Globally, Central Banks are determined to commit to low rates to stimulate spending and support growth. Governments continue to provide fiscal stimulus to support the economy, until we are safely able to hang our “Open for Business” signs again. Though we benefit from this positive market trend, we continue to be vigilant, and concerned about valuations in certain sectors and geographies of the public equity markets. The “Buffett Indicator” highlights the over-valuation of US equity markets, relative to historical averages:
But that was twenty years ago…
It is times like this, when experience can be the best teacher. We need to remind ourselves that forecasting the direction of markets and predicting changes in investor sentiment, is a formidable task. While at times you may be able to ‘make the right call’, intuition should not be relied on as a source of return that we can depend on with consistency. WealthCo continues to be fully allocated to equities for our clients at ~ 35% of their target exposure, having sold down public equities over the course of the quarter. Selling the outperformers and re-allocating capital to private debt/private equity markets, helps us to maintain discipline around our long-term strategic asset mix. In these markets, risk is priced through negotiations between private buyers and sellers. This direct negotiation may result in “fairer” pricing of risk and return with less influence of the animal spirits in market behavior.
In the spring of 2000, the bursting of the Internet Bubble occurred a full four years after Alan Greenspan coined the term “Irrational Exuberance”. At its core, irrational exuberance is a state of mania. When related to the stock market, it occurs when investors are so psychologically invested in the price of an asset going up, they lose sight of its inherent value. Interpreted, this phrase indicates that the stock market might be overvalued. As the first quarter of 2021 draws to an end, we need to ask whether we have reached the stage of ‘Euphoria’ in the Cycle of Investor Emotions – are we at the ‘Point of Maximum Financial Risk’?
Anecdotally, today’s market feels much like it did back in 1999. Twenty years ago, I was starting to build my career at AIMCo. Nortel comprised over a third of the Canadian equity market, and day-trading internet stocks seemed to be a legitimate and lucrative side-hustle. Today, technology companies are generating revenues with solid business models, which are both scalable and profitable. However, do they deserve to make up a greater portion of equity market capitalization, where the top six names represent ~22% of the S&P 500? We can easily identify examples of speculative practices, related to the pricing of assets in public equities (Gamestop and AMC readily come to mind). These behaviors are also reflected in the Canadian housing market — where homes are sold at well-over their asking price. We need only look to TINA, to see what is driving these actions.
At the Copa (Copacabana) …
As Portfolio Managers, we feel we are closer to the ‘Point of Maximum Financial Risk’. We are mitigating this by positioning our portfolio defensively, thus allowing us to control the shape our portfolio takes. Our long-term goal is to create value by emphasizing execution risk, while reducing cyclical and economic risks. This is reflected in our portfolios through:
Diversification into private markets which may benefit from inefficient pricing of risk
Higher valuations create opportunities for exit. For example, a private company in the Alternative Growth pool went public at a significant multiple of book value due to investor demand for higher growth companies.
Contrarian investments in securities or strategies that are complex in nature where dislocations create opportunities for excess return.
Reduction to US large cap exposure in favor of emerging markets, which have younger population demographics and expectations for higher structural growth (increasing consumption due to the rising middle class).
Developing real estate assets, such as data centers and logistics warehouses, which will continue to benefit from increasing demand for data and e-commerce retailing.
Now it’s a disco, but not for TINA …
At WealthCo, we are committed to keep the disco going, building a diversified portfolio with access to many more opportunities than just the capital we manage. Our incremental dollar goes to new ideas that do not double down on the existing risks inherent in our portfolio. We endeavor to be disciplined in how we review investment opportunities and continue to create a wide funnel of options. This ensures we develop client portfolios which have many alternatives, rather than getting stuck with TINA, and having to take on ever more risk in stocks and bonds. We want to minimize the role emotions can play in investing and keep our focus on the inherent value of assets. We will heed the warning Manilow croons in his final lines “don’t fall in love”, and we will invest with our heads, not our hearts.
Peter Lieu, CFA
Chief Investment Officer
WealthCo Asset Management