You may be wondering how to navigate these grand distortions and delusions.
We are too. In fact, we believe it is the most important threat you face as an investor right now. That’s why we spend so much of our time researching and writing about it at Bonner & Partners.
The first thing to understand is that credit expansions, and artificially low interest rates, foster unsustainable booms. Inevitably, these booms are followed by crashes.
This is what happened in the Roaring Twenties… in the dot-com boom… and in the subprime mortgage boom. That’s because when central banks manipulate the information interest rates convey investors can’t help but misallocate capital – often on a grand scale.
As Austrian economist Ludwig von Mises wrote in Human Action:
But now the drop in interest rates falsifies the businessman’s calculation. Although the amount of capital goods did not increase, that calculation employs figures which would be utilizable only if such an increase had taken place.
The result of such calculations is therefore misleading. They make some projects appear profitable and realizable which a correct calculation, based on an interest rate not manipulated by credit, would have shown as unrealizable.
Entrepreneurs embark upon execution of such projects. Business activities are stimulated. A boom begins.
The result of such calculations is therefore misleading. They make some projects appear profitable and realizable which a correct calculation, based on an interest rate not manipulated by credit, would have shown as unrealizable.
Entrepreneurs embark upon execution of such projects. Business activities are stimulated. A boom begins.
The first duty of a prudent long-term investor is to recognize the situation for what it is: a period of false prosperity brought on by market manipulation.
The second duty of a prudent long-term investor is to protect himself from such distortions… and the day of reckoning that will follow.
This involves two things: a unswerving focus on value and an ability to resist crowd psychology.
This is why, for instance, we have been recommending emerging market stocks over their developed market counterparts, despite the negative sentiment lately toward the emerging world.
Crowd physiology clearly favors stocks in the US over stocks in the emerging world. But clearly valuations favor the emerging markets.
The US stock market is trading on a Shiller P/E (which looks at the average of 10-year earnings adjusted for inflation) of about 25. Emerging market stocks are trading on a Shiller P/E of just 14. That’s a big discount.
Added to this, real earnings per share in the US are about 50% above their long-term trend. And real earnings per share are 10% below trend in the emerging markets.
The question then is a simple one: Do you invest in a highly distorted market with relatively high valuations and above-trend profits… or a less distorted market with relatively low valuations and below-trend profits?
We think you know the answer…
Regards,
Chris
Further Reading: We recently attended a private meeting of the ultra-wealthy in London to find out how they manage to make and hold onto wealth in the world of funny money. It turns out they have a private set of “rules” to grow wealth that few people know about. If you want to find out the criteria the super-rich use to select investments – and how you can use it to build independent wealth – go here to learn more.
