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The Cult of Equity Is Dead. Long Live Equities.

In pre-republican France, upon the passing of a sitting monarch the Duc d’Uzès would proclaim “The King is dead. Long live the King!”

The idea, of course, was that a new king was rising up to take the place of the old. The Crown as an institution was alive and well; it was just that the head under it had changed.

I was thinking about this as I read a headline in today’s Financial Times: ‘Cult of Equity’ said to be dead.

 

The FT quotes Alister Hibbert, one of Europe’s leading fund managers, as saying “I think the cult of equity is dead.” This follows similar statements last week from Citi’s equity strategists that an “immediate reincarnation of the equity cult seems unlikely.”

Whenever one hears “equities” and “dead” in the same sentence, it’s tempting to draw parallels to the oft-lampooned August 1979 BusinessWeek cover that announced the “Death of Equities.” More than thirty years later, the unfortunate editors of BusinessWeek have the distinction of printing what was quite possibly the greatest contrarian indicator in history.

There is a difference, however.  Mr. Hibbert is not saying that equities are dead.  He is saying that the cult surrounding them is dead, describing the sentiment of investors who no longer believe that stocks are “guaranteed” to make them wealthy.

The 1949 book The God That Failed was written by a prominent group of ex-communists who chose the provocative title to describe their own prior cult-like faith in Marxism.  In 2001, Hans-Herman Hoppe wrote a similarly titled book in 2001, Democracy: The God that Failed, in which he described the belief in universal democracy as being based on religious-like faith.  Neither ideology proved to be the panacea that its adherents believed as the bloodshed of the 20th century proved.

For many investors, particularly those in or nearing retirement, their faith in stocks has likely been permanently jaded.  Add equities to the list of gods that have failed.  The colossal 2007-2009 bear markets wiped out more than a decade’s worth of gains for investors who faithfully bought and held throughout the 1990s and 2000s.  Retirement dreams for many have been ruined.  Disgusted with the entire business, many have taken money out of the equity markets altogether and have opted for the “safety” of bonds.

During asset bubbles, investors engage in cult-like behavior en masse.   They cease to view their investments dispassionately, and when evidence or common sense would suggests that their faith is misplaced they get defensive.  (Read the comment section under my previous article on gold, and you will understand what I’m saying.)  But when faith begins to crack, sentiment tends to go too far the other way.  Investors oscillate between having too much faith and not enough. For those who are able to keep a level head, all of this is good news.

As I wrote in a prior article, many staid American blue chips are now priced to deliver respectable if not spectacular returns.  Dividend yields on many are well in excess of bond yields.

Returning to Mr. Hibbert, he would appear to share this view: “Given that the starting valuation for equities is now very low, then if those companies can continue to increase their earnings profile I think you will see very strong returns because you will get both capital growth and dividend yield.”

The death of the Cult of Equities is a once-in-a-generation blessing for those investors with the patience and temperament to wait for sentiment to improve.  With dividend yields as high as they are currently, they are being paid handsomely for their patience.

The Cult of Equities is dead.  Long live equities.

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Risk, Return, and Reality Revisited

This article originally appeared in the November 2008 HS Dent Forecast Newsletter. In the year and a half that has passed, the key insights remain: this recession is fundamentally different from all others of the post-WWII era.

On Friday, October 24, 2008, the Financial Times reported that swap spreads turned negative. It would be easy to dismiss this headline as just another bit of media noise except for one little technicality: according to all of the rules of finance, it is a mathematical impossibility. A negative swap spread means that the Treasury yield is higher than that of a swap of a similar maturity. As the “risk free” rate in virtually all financial models, the Treasury should always give the lowest taxable yield without exception. The pricing in the swaps market implies that the private issuers of swaps are somehow less risky than the U.S. government! Of course, this is absurd. All doubts about the fiscal responsibility of the government aside, no private company can ever be less risky than the U.S. government. With unlimited ability to tax and, if need be, print the needed money, a sovereign government by definition cannot default on debts denominated in its own currency.

Meanwhile, across the Atlantic, we found another absurd anomaly. Volkswagen briefly became the most valuable company in the world! A rush of panicked short covering caused the stock to triple in one day before finally easing to lower, albeit still grossly overvalued, price. Short sellers of Volkswagen found themselves wiped out…in the middle of an economic contraction that has decimated the auto industry.

Nassim Nicholas Taleb must be proud: “Black Swan” has become a standard expression in the American financial vocabulary, and his 2007 book by that name could not have been timelier. In Taleb’s context, a Black Swan is a high-impact, low-probability event beyond the realm of normal expectations, something along the lines of a tornado or earthquake in the natural world. Such natural disasters are highly destructive when they hit, but they are infrequent enough to make living in high-risk places such as Oklahoma or California possible and, in a financial context, affordable to insure. The problem, as Taleb repeats throughout his writings, is that in financial markets, “low-probability” events are a lot more common than our standard models allow.

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Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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