Handcuff Volunteers

A few weeks after the election, a friend of mine told me he sold all of his stocks in his 401(k). He was happy with the 13% his portfolio earned in 2016 and felt that stocks had gone too far too fast. He understands that he can’t time the market, but he just couldn’t help himself. His mind was made up and he would get back in when stocks came back down to earth.

I’ve had conversations with other friends and family members asking me if they should take similar measures. Now these are just anecdotes, indicative of nothing really, but it does seem like there is a giant disconnect. Civilian enthusiasm for stocks, at least from my perch, is nowhere near euphoria, but at the same time stocks are expensive on basically every single metric.

So people are paying more for stocks as they make new all-time highs, and yet the “feel” is more this is gonna end badly than I don’t care just get me in.  How can these two contradictory things exist simultaneously and what is creating this disconnect?

Howard Marks commented on this recently in his interview with Barry Ritholtz and said interest rates are responsible:

I don’t believe most people are thinking very optimistically. I think most people have reservations, most people understand that economic growth is uncertain, most people understand that we don’t know how the central bank experiment with zero rates is gonna end up or how it gets reversed, and of course most people are concerned about the geopolitical developments in the world today. I believe that enthusiasm is not unrestrained, on the other hand, people may be thinking in not a bullish way but I think they’re acting in a bullish way. What accounts for the difference? Rates near zero. And when you live in a low return world, you have to take risk to get return. People are willing to take risk because they’re hand cuff volunteers. People who do things not because they want to, but because they have to.

This morning Home Depot reported earnings and announced that they’ve raised their dividend to 89 cents, or 2.48%, right around where ten-year rates are at. Would you rather lock in low returns from bonds or accept volatility from stocks? This seems like a no brainer, and it is, but at some point stocks can cross a level where valuations just don’t work. For example if a $100 stock is earning $10, it would take ten years for an investor to get paid back on their original investment, assuming no growth, no dividends or buybacks, and a fixed capital structure. But If that same $10 of earnings is now supporting the stock at $200, it will now take twenty years for a new buyer to get paid back. At some point, investors will collectively say no, driving the price back down to levels where it makes sense to bear risk.

It’s entirely possible that central bank policies have made investors handcuff volunteers, and with the passage of time we’ll find out if we were oblivious to this risk. The other possibility is stocks won’t crash as a result of zero interest-rate policy, and history will conclude that central banks have orchestrated one of the greatest financial rescues the world has ever seen.


Masters in Business, Howard Marks