A family trust and family investment fund comes with many products I am not as familiar with as I would like to be. Of course, I know the basics of the financial instruments — public equities, hedge funds, commodity trading, REITs, farmland, etc. … but that is like saying “I understand what a Preferred Series is in venture capital, so I understand venture capital investing.” I don’t see a bull but I smell it. But now, I need to have an opinion about it. Here it is.
Tactical: Volatility Ahead
What I hear from my startups’ customers is a contraction in business activity. And not just as in early-summer-break-during-Covid. I overheard one investment manager say that this is like 2008 — massive gains ahead this year. I think we will see lots of false starts and high volatility: I don’t think that the supply chain issues I can see across all industries (and my car parts!) will resolve, Covid-19 in China will stop, and unemployment in the US suddenly drops (why?!). I will play selective, defensive, diversified, hedged. That is to say: S&P500 first falls to a soft landing (3,700? 3,800?) over the next month because of concerns around inflation and recession … and then climbs to 4,200+ overt the next 2 months — because there is too much money in the market, too many bonds and credits and swaps and people who got hired and wealth that got created in Q1’22, before the war on Ukraine. The money needs to be put into the ground, and people want a career…. and because current valuations are not a reliable guide to short-term performance.
Valuations Correlate with Long-Term Returns!
Nasdaq says the S&P500 trades a trailing P/E ratio of about 20.5x … that smells like a healthy 7.2-9.5% range over the next decade. And Bond market yields also improved significantly this year — government bonds are almost a the highest level since 2018.
Time is Money. Don’t Wait.
I am a value investor. I have a long, 15+ year time horizon. I don’t have the time to be tactical. I cannot follow the markets on a daily basis, and neither do I have the qualifications and experience to do so. I do not believe that there will be another short-term 10%+ sell-off in the next 6-9 months (besides another black swan event, in which case my hedging and swaps kick in). Why is that important?
- Scenario 1 “INVEST”: I buy now at perhaps 8% to 11% yield (including dividends, remember those?) .. but perhaps get hit with a 10%+ short-term sell-off market slump in the next 6-9 months. The market recovers and continues to grow.
- Scenario 2 “WAIT”: I wait with my equity investment and instead hold cash, perhaps in government bonds, at 3% yield. I wait until a 10%+ sell-off occurs, and I buy into the market then at the short-term 10% sell-off discount. If the price then recovers, I will make 10%+(8% to 11%), or now about 20% return in the first year. If a sell-off doesn’t happen, I still have the 3% yields of the government bonds and will start investing in one year (or whatever my nerves of FOMO tell me ;))
In scenario 1, “INVEST”, I would earn 8-11% yield in the first year if no sell-off occurs. my scenario 2 “WAIT” strategy has to outperform that yield to make sense. The simplified formula for that is
(sell_off_probability * 20% + no_sell_off_probability * 3%) must be greater than 10%.
where no_sell_off_probability is obviously (1-sell_off_probability), the inverse of the probability of a sell-off. That means that I need to have a 41%+ certainty that, within the Scenario 2 “WAIT” 1-year period, there will be a 10%+ short-term sell-off and recover to previous levels… hm…
Compounding can be a blessing. But contrarian hedging for short-term volatility will still be part of my strategy. Germans. Risk management.
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