Martin Pelletier: Ask how you could be wrong and seek out research on the other side of the argument
Traders work on the floor of the New York Stock Exchange. Photo by Spencer Platt/Getty Images files One of the golden rules about investing that I’ve learned over the years is to never personalize a particular strategy or trade, and instead search out reasons why I may be wrong.
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One well-known financial pundit on social media put it best when he said that he purposely sends out tweets with a strong contrarian statement and if it’s vigorously criticized, then he knows he’s on to something.
I experienced this backlash myself last year when I publicly highlighted the risks of owning bitcoin, the price of which has since been cut nearly in half. That said, my call on Tesla Inc. has yet to materialize, with the stock up more than four per cent since the end of March 2021, although my thoughts around it have not changed.
I also received the same kind of response at the beginning of the year and again more recently after warning about the dangers of adding more equity duration into your portfolio, especially in a rising rate and inflationary environment.
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There is almost a cult-like addiction to these segments of the market, just as there was back in 2014 among oil investors amid that peak market and the dip buying that followed, or, dare I say, earlier this year among Canadian real estate speculators.
However, I can’t really blame them as it is in our DNA to think that the longer something works, the greater the chance it will continue to work indefinitely. Flip a coin and get heads 10 times in a row, and then ask someone what the chances are of getting heads again.
In the case of long duration equities, despite the recent pullback, the tech-heavy S&P 500 has delivered an annualized return double that of the MSCI EAFE (Europe, Australasia and Far East) index and more than four times that of emerging markets over the past decade at 14.3 per cent versus 7.1 per cent and 3.4 per cent, respectively.
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Even with the strong rally this year in energy stocks, the S&P 500 has still bested the S&P/TSX composite’s 9.9-per-cent annualized return by a wide margin over the past decade.
If past performance is truly indicative of future performance, that implies that any weakness is to be bought up. And, according to the feedback I’m hearing, there are still plenty of investors, investment advisers and even portfolio managers who believe this year’s pullback in long duration equities will surely rebound and quickly reclaim their former glory.
Just like bitcoin advocates, they stomp their feet while saying how dare you question this new world, one dominated by a permanent low-cost-of-capital, quantitative-easing-fuelled technological ecosystem that will result in permanent Japanese-like deflation.
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More On This Topic Investors should be more wary of buying into the duration trap, not the value trap Remaking once solid investing strategies for today’s markets Here’s a better strategy for investors than trying to catch falling knives This isn’t surprising since the powerhouse S&P 500 has evolved with more and more exposure to longer duration equities such as technology. Its top 10 companies now represent more than 28 per cent of the entire index, and eight of them are tech, according to J.P. Morgan Asset Management Inc.
Demand for these companies has been so strong that they are still trading at a P/E of 25.7x, which is 129 per cent of its long-term 20x average. As an interesting side note, the remaining stocks in the index are trading at 15.3x, just below its long-term average of 15.7x.
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Article content Jurrien Timmer, director of Global Macro at Fidelity Investments, posted a great thread on Twitter about this. The problem, he points out, is the risk that the earnings growth narrative will unwind, thereby pointing to a market that appears to be fairly valued despite this year’s large multiple compression.
I would take this a step further given the shift in consumer spending from goods towards services. If you would like some boots-on-the-ground examples of this, try booking a holiday for this summer or search online for some of the experiences lately at airports. This, by the way, is great for traditional areas of the market such as commodities.
If you find comfort and safety in the herd, ask yourself what others are doing and whether this is reflected within your portfolio. Then try floating some contrarian questions amongst that herd to see what their response is. Finally, ask how you could be wrong and seek out research on the other side of the argument, not just from the herd you’re in.
Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.
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