Low inflation, super low interest rates, lots of liquidity, a fed that has been kind to risk assets make up the backdrop that has seen real estate, stocks, collectibles and other assets dramatically increase in value since the great recession of 2007-2009.
This has led to some extremely high valuations in many of the most popular investment themes since the recession.
What You Could Have Done
For example, in recent years, you could buy a handful of “Big Tech” stocks and make a fortune. The so called “FAANG” stocks ruled the roost, and most portfolios held them.
Those stocks were:
- Netflix and
Since these 5 stocks comprised more than 15% of the S&P500 and 30% of the NASDAQ indices overall value.
This made the index values rise disproportionately to the overall market over the past 10 years.
What Goes Up, Comes Down Faster!
I have discussed this topic many times over the years. It can take years to see an investment to rise by 100%, while dropping in half can happen in a few days or weeks. People always seem surprised when this happens, but we see it all the time.
For example, as of this writing, when we look at the FAANG stocks this year, we see that Facebook is down 71% for the year, but just a few weeks ago, it dropped by 30% in just 2 days! Amazon is down 46% for the year and had a 14% drop in 1 day.
Netflix is down 56% so far this year and had a one day drop of 35%! Netflix has wiped out 4 years of appreciation in less than one year. I could go on, but you get the idea.
Watch Them Implode
I am always reminded of this phenomenon when I watch them implode a building. It might have taken years to build but comes down to rubble in less than a minute. Amazing stuff. That is why one needs a sell strategy if you are going to invest in stocks or other securities. Either a price target for selling, a stop loss discipline, or other technique that one sticks to is essential if you are going to invest in things that can go down in value.
The First Law of Wall Street
One of the first wall street “laws” I was taught early in my career is that “Nobody ever lost money taking a profit”. I can’t tell you how many folks I have spoken with in the last 5-10 years who owned those FAANG stocks along with stocks like Tesla and Microsoft which had appreciated hundreds of percent over the past decade or so. After they show off the appreciation with great pride (deservedly so),
I ask when they plan to sell and am usually met with odd looks and something like; “If I sell, I will have to pay taxes”. If you find yourself in one of these positions, ask yourself, “if it were to go down 30%, would I sell then?” See, that loss is like a tax itself. Then you sell and still pay tax.
So, Interest Rates and Inflation Are Up, That Is Bad, Right?
A lot of headlines these days are some versions of the above. Many are saying that with higher interest rates the economy will fall apart, and inflation will ruin everything. Pundits are talking about inflation killing our economy or ruining asset values.
Fear has replaced greed as the primary motivator for investment decisions and many folks are stressed. What can be done to prevent a meltdown and preserve financial security?
5 Things To Keep In Mind In The Coming Years
- Keep perspective. This isn’t the first time we have had high inflation in this country, and we have survived. In fact, inflation rates were more than double the worst we have seen this year, just over 40 years ago. Things are different than we have seen for decades, but what we are experiencing is mild compared to the late 1970’s and early 1980’s
- Past performance is no guarantee of future results. Just because something was good, doesn’t mean it will be again. Many of the leading stocks I mentioned earlier in this post might never return to their previous price levels. Some may not even survive the next few years! Just look at the S&P500. That index was introduced in 1957.According to a Bloomberg report, as of March 2007 only 86 of the original 500 companies are still in the index. Companies come and go, a very valuable lesson to remember.
- Interest rates are relative. When it costs more to borrow, savings earn more and visa versa. Interest rates peaked in 1981 at about 15% on the 10 year treasury. The current level of over 4% was the norm before the great recession of 2007-2009. Since then, we have seen the rate lower than at any point since the 1950’s. For the most part historically, the rate has been between 4 and 6%. These rates are more “normal” based on history.
- Debt is becoming more expensive. Over the past 10+ years, we have seen a lot of governments and companies borrow heavily as interest rates were at record lows and they just couldn’t resist. This trend accelerated since 2020 once interest rates hit rock bottom. Companies used this borrowed money for everything from buying other companies, to building factories and to buy back a record amount of their own shares.According to Bloomberg, highly leveraged companies will be challenged to refinance debt as it comes due as rates have gone up and fewer folks have an appetite for corporate bonds. If they can refinance to higher rates, some will find it hard to be profitable while paying the higher debt service. This might lead to some capital-intensive companies becoming unprofitable or worse.We have seen a number of big companies drop dramatically in value as investors worry about their ability to pay back those debts.
- Lots of income properties are leveraged. Over the last 5+ years we have seen cash flows from quality income properties come down as values were rising at faster rates than rents. I have seen multi family properties sell at under 4%, and in some cases, 3% cap rates.The cap rate is the amount of net cash flow an investor receives from a property after expenses.Many commercial loans are less than the 15-30 year terms that residential mortgages typically have. Many have balloon payments after 5-10 years that will require owners to refinance into a new mortgage at much higher rates.If the cap rate is low already, there may end up being little to no cash flow from those properties. If the owners raise rates to cover the increase, tenants might move and then the owner would be “underwater” and forced to sell to avoid monthly losses that might not be sustainable.If you own property or are invested in a real estate backed security like a REIT, you might want to check on the mortgage status of your investment and become familiar with the terms of those loans. Then you can decide if the investment is still viable going forward.
It’s Not All Bad News
No matter how bad the economic news gets, or the gloom that descends on a market, I have yet to see a time when everything is dropping in value. Even during the great recession and the great depression, there were opportunities and investments that went up.
Recessions are really a “reordering” of the economy. Things that are no longer benefiting from current conditions have to adjust to their “new normal” or step aside for those who will thrive in the new environment.
Remember, some of the great fortunes amassed through history have their seeds in hard economic times. The markets are evolving, many of the winners of the recent past will never recover, many will disappear.
You Need to Adapt and Change
As things change, you will also need to adapt and change if you want to succeed and built financial security. Take the time now to look at your overall picture and talk with your advisers about how to adapt to this new environment.
If all they can do is tell you to hang in there it will all be fine, you may want to ask them why they are making that recommendation. You might want to consider a different approach.
Feel free to contact us if you want a second opinion or just want to discuss some of these ideas in greater depth. Being proactive will help you enjoy a Happy Retirement!