Quick Set Up
Back in early July 2021, I unleashed: My Two Vanguard Beasts. I reviewed two funds for readers:
- Vanguard Small-Cap Index Fund (VSMAX)
- Vanguard 500 Index Fund (VFIAX)
I looked at the price history of these funds, but I also compared them to three stocks and the Nasdaq 100 (QQQ).
I provided a few key points at the end of the article that I'll start with here:
I'm thinking that even with returns of 4-6% over the next 10 years, I'll be fine. My gut says that returns won't be down into 4-6%, but also not anything over 12%. Instead, we'll likely see something more like 7-8% in the next decade. I've got no crystal ball, but I still like my guess.
And also, this:
To be frank, I can virtually guarantee that both VFIAX and VSMAX will beat many of my most "intelligent" stock picks. The market humbles and humiliates. I'm going to win some but I'm going to lose too.
I'm coming back to the original article and these key points because a lot has already happened here in the second half of 2021. In this article, I discuss performance, money printing, inflation, and the biggest risk to my investments, including VSMAX and VFIAX.
Let's look at how things have gone over the last five months or so. I'm also including IBM (IBM), Berkshire Hathaway (BRK.A) (BRK.B) and Visa (V) because they were highlighted in my previous article.
First, I'll point out the obvious. Both IBM and V have done quite poorly in the last five months. Both are down about 16%, give or take.
I've written about these two companies:
- IBM: Dead Dinosaurs Can't Dance (November 6th)
- Visa: Keep Calm And Carry On (November 23rd)
Clearly, I'm bearish on IBM while I'm bullish on V. And, interestingly, here's what I wrote about both of these companies previously, after my analysis:
Just to be clear, I've owned IBM since November 2012, BRK.B since June 2011, and Visa since Oct 2014. However, for the sake of easier comparison, I've narrowed the timeframe to five years. It's still instructive.
First, it's really clear the IBM is the biggest loser and V is the biggest winner. This is perhaps the best representation so far that growth is beating value. It's not even close.
Now, back to the chart above. Since early July 2021, QQQ is the biggest winner, up about 9%. The VFIAX is up about 7%. Both BRK.B and VSMAX have muddled along, moving up 2-3%.
Beating the market is very difficult and being selective in 2021 is critically important. Investors should be sticking with the broad markets, or they should follow their plans to achieve very specific goals. That is, "buying income" with high yield stocks, being a "value investor" by picking beaten-down stocks, using "dividend growth investing" to ratchet up a growing pile of dividends over time, and so on. Active management is fine, if you've got a plan and a clear systematic approach.
I also want to show this very clearly:
I'm almost certain that you're aware of what's happened. In the short term, almost everything is down due to a new COVID variant. Interestingly, V is down the least. I believe that's partly because the stock is near a floor, although I could easily be proven wrong. The point is that there will be hiccups along the way, but the general direction of the market is still up.
Hot Market Versus Melting Ice Cube
In February 2021, I wrote There Is No Bubble. I explained:
Unlike the Great Financial Crisis, the money being printed now is not just pouring into banks for stability. Instead, dollars are now bleeding out into the general economy and - quite literally - into the hands of individuals who spend. The real-world money supply is increasing.
Of course, that means that many businesses are succeeding and their profits will soar, and continue to soar. In turn, this will almost certainly drive asset prices even higher. In short, money printing is inflating the bubble because money is chasing assets. Buying debt (i.e., bonds) is "dumb" and people who are saving are getting killed. [Emphasis: Author]
Here's how things have gone from when I wrote that:
Obviously, we're coming off 2020, which was a really weird year. The money printing has been incredible, which simply adds fuel to the market. Further, as I previously explained, just holding cash has been a losing game.
Inflation Impact: Savers Are Now Investors
Many "savers" have been forced to become "investors" because holding cash means you're not keeping up with inflation. Also, there is the fear of missing out on huge gains. The net effect is that vehicles like VSMAX, VFIAX and QQQ have become savings tools - putting money further out on the risk curve just to maintain purchasing power. Cash is optionality when things go sour, but that cash is also losing power. This is why Michael Saylor (MicroStrategy (MSTR)) moved into Bitcoin (BTC-USD). According to Bloomberg:
Before the Covid-19 crisis, the Tysons Corner, Virginia-based company had about $500 million mostly invested in short-term U.S. government securities. Saylor began to question that conventional strategy when yields tumbled in the wake of the pandemic. He estimates that so-called asset inflation will surge to more than 20% a year, eroding purchasing power.
"Once the real yield on our treasury got to more than negative 10%, we realized that everything we are doing on P&L is irrelevant," Saylor said. "We really felt we were on a $500 million melting ice cube."
You don't have to agree with Saylor's choice to move into Bitcoin. However, his slow growth but profitable company was getting no love at all. The $500 million in cash on the balance sheet was largely ignored, and the valuation of the business was otherwise quite weak. So, he moved out on the risk curve.
Sidebar: Obviously, Bitcoin bulls don't see buying Bitcoin as more risky, but instead, it's seen as being less risky. Nevertheless, Bitcoin investors have still experienced volatility, no matter how you slice it.
Back on track now, here's how Saylor's investment has worked out since Bloomberg ran their article on MSTR back in November 2022:
Clearly, the markets have done really well over the last year. VSMAX, VFIAX and QQQ are all up over 40%, which is quite impressive. However, Bitcoin and MSTR have beaten the markets by a dramatic amount. And, if we're to believe the official numbers, the markets are also beating inflation, although as explained, cash is losing out.
Just to be crystal clear, seeking safe returns with bonds isn't working. Well, at least not in relation to inflation. For example, Treasuries aren't even close to beating inflation right now:
And, we know from history that inflation destroys wealth.
Warren Buffett, not fond of short-term calls on the economy or market, had plenty to say earlier in his career about what inflation can do to stock market wealth. Buffett's view of inflation was heavily influenced by the runaway inflation of the 1970s. "Inflation is a far more devastating tax than anything that has been enacted by our legislatures," he wrote in 1977. "The inflation tax has a fantastic ability to simply consume capital. ... If you feel you can dance in and out of securities in a way that defeats the inflation tax, I would like to be your broker - but not your partner."
In summary, while money printing and any associated inflation is nasty, savers are pushing more and more money into the broad markets. This is currently providing a floor. However, if the music stops, the markets will fall.
Dry Powder, So Where's The Risk?
Oddly, or perhaps counterintuitively, because of both money printing and "rational paranoia" about COVID, there is a lot of cash on the sidelines.
Cumulatively, Americans are sitting on piles of cash; they have accumulated $2.3 trillion more in savings in the last 19 months than would have been expected in the pre-pandemic path. The median household's checking account balance was 50 percent higher in July of this year than in 2019, according to the JPMorgan Chase Institute.
My point is that money printing and inflation aren't directly putting the market at risk. In fact, asset prices just keep going up. Again, savers are pouring in money to keep floating plus there's money on the sidelines, ready to pounce.
The idea has been don't fight the Fed and buy the dip. Once these narratives break, then the market will be at great risk.
It comes down to one word: trust. If Americans, and the world, lose too much faith in the Fed or by association the U.S. dollar, we could see a severe decline in all markets. In fact, I suspect we'd see a radical decline in all assets.
Ultimately, bubbles don't cause problems. It's when they pop we feel the pain. And, similarly, it's not high valuations. The drop causes the suffering.
As I have explained previously, some stocks can stay elevated for a very long time. Years and years, in fact. Very few investors are bothered by high P/E ratios, for example. As long as those stocks keep flying, there's no problem. It's the P/E compression that hurts. The same can be said about markets.
I suspect that even with this new COVID variant, we'll keep going higher as the Fed keeps printing. A little tapering isn't going to do much either. As I've pointed out before:
The stock market - when viewed in its entirety - is relentlessly going up and beyond normal levels in almost every "traditional" way we can imagine. If nothing else, the fact it came back so strongly from COVID-19 is a testament to the inflation of the bubble. It's my assertion that the twin power of money printing and low interest rates is greater than the pandemic at this point. Unless there is another macro event (e.g., war, another pandemic, natural disaster), the stock market will keep inflating for now.
And, we've seen this show before:
Source: Google News
As long as the U.S. does what it's been doing, the markets won't drop and stay down. There's too much cash in the system, and it's got to keep flowing into the markets even if there are drawdowns. And, again, this all stops once there is a severe loss of trust in the government and the money.
To wrap up, I continue to be bullish on VSMAX and VFIAX because of money printing, inflation, low interest rates and the Fed's current money positioning. Therefore, the biggest threat to my two Vanguard beasts is a loss of trust.
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