Volatility has come back into the equity markets, driven by rapidly increasing Treasury yields. In fact, since the vaccine data came out towards the end of last year, Treasury Bonds are down 27.7%, meaning yields are up. This has coincided with value stocks and financials going on a massive rally and outperforming peers, after a long period of underperformance. Treasury yields are rising because of good economic news. You have massive stimulus, the vaccines are going out at a rapid rate, which will only increase in the next few weeks and months. Businesses are doing well and consumers are healthy, but of course there are areas of weakness such as travel and leisure. Recently, I’ve been to Las Vegas and I can tell you it is a different world than the Vegas of yesteryear, and while demand will increase it won’t be the same as it was unless the guidelines change substantially.
With improving economic fundamentals, you have an overvalued stock market. The vast majority of investing has been price agnostic, think index funds and the speculation we see in almost every asset class. Higher interest rates pressure the prices you are willing to pay because the opportunity cost or discount rates increase. This is most noticeable on longer duration assets such as long-term bonds, or overpriced growth stocks, where most of the earnings are expected to occur far into the future. Yesterday the Nasdaq was down nearly 4%, which was the biggest selloff in 4 months. Naturally that drags down other stocks too, but from a business perspective, we are invested in companies that should actually earn more money when interest rates rise. That is a huge difference and it is why I believe we can see strong performance over these next 5 years, even if the overall market is flat or negative, which I think is very likely due to the starting valuations.
A negative scenario for us would be more lockdowns. Reopening and higher rates are good, lockdowns are bad for us from an investment standpoint. I had a conversation with someone about index funds the other day and they rightly pointed out just how well they have done over the last decade particularly. Keep in mind that, after 2000 it took 12-14 years, depending on the index, to get back to even. I reference 2000 because it is the only time stocks were more expensive than now. When that bubble collapsed, value went on a historic run and I believe the stage is set once again. After 1929 until WW2, and from the late 60’s to the early 80’s, the indices had similar decade-long periods where they were negative. The last 40 years has seen declining interest rates. This arguably single most important factor driving investment returns is literally impossible to repeat over the next 40 years. Simply following recent history as a guideline is very likely an easy way to assure failure, which is why we need to think and invest differently. That can put us at odds with consensus, which isn’t always good over the short-term as we saw in 2020, but long-term I think it will be absolutely essential and massively beneficial. If you look at the options we have been selling, we have taken advantage of volatility collecting huge premiums way out of the money on both the cash-secured put side and the covered call side. Many of our stocks could drop 30% before we would lose a penny, assuming we hold the put option till expiration. That is why you want to ignore the day to day noise, as often it relates to just changes in volatility, which becomes meaningless at expiration.
Johnson & Johnson released very positive Covid-19 data earlier this week and is being reviewed today by the FDA. Most likely it gets approved later today or this weekend and distribution will start immediately. Remember, that it is 1 shot and it is easier to store, so that rollout will greatly accelerate the vaccination campaign. It will be hard to justify many of the most stringent restrictions when everyone that wants a vaccine has one, and people are going to realize really quickly just how fast the number of vaccinated, or previously infected, people are in this country that now will have some type of immunity/resistance. This is fantastic news for both civilization and the real economy, but if it leads to higher rates, sure that can hurt a lot of stocks, but these are mostly the stocks that are dramatically overvalued anyways and we don’t own. Keep that longer-term perspective, whether that is a year at minimum, or hopefully much longer, I think you will find this to be a very fruitful year and future.