Investment insurance for the two biggest risks in markets today

There are two general risks in investing – losing money, and not making it.

These are constant, but investors fear one more than the other depending on who they are and how they feel.

As time passes though, specific risks become more relevant.

Sometimes there is a high risk of a crash, like if you were a property investor in 2006, or a tech investor in 1999.

When I look today, investors face two major specific risks – price inflation in the things we buy and use, and a stock market crash.

Let’s take the risk of a crash first.

On a whole heap of different valuation metrics, stock markets look wildly and broadly overpriced.

The analogy I often go to is that people are buying £1 chocolate bars for a fiver.

Since the financial crisis, economies have grown rather weakly – at 1% or 2% per year, while stock markets have grown maybe eight or 12% per year.

This is especially true in the US.

The stock market relative to the economy is a classic metric, favoured by legendary investor Warren Buffett, and reflects how much more people are paying for each slice of the economy.

After the financial crisis of 2008, the American stock market was only 60% as much as its GDP.

Now, it’s broken through the 200% mark for the first time in history.

There are more constituents of the S&P with a price-to-sales ratio now than there were even at the very peak of the tech bubble in 2000. These are the ten-pound chocolate bars. Heck, maybe I’d stump up a tenner for some Lindt, or the really good stuff you know. But when the Cadbury and Galaxy bars of this world are going at such high prices, it’s time to get worried.

Howard Marks taught me that markets move in cycles.

People move from fear, towards greed. When they are more worried about not making money than losing it, they overpay for assets. When that happens, as now, we should proceed with more caution.

He uses the analogy of a pendulum swinging. It often goes through the midpoint, and swings through to an extreme, before the fundamental forces which govern it cause it to slow, and start its return leg.

The fundamental forces which govern markets are not physical. They are two-fold: fundamentals, and investor psychology.

Fundamentals, the earnings of the companies we buy shares in, tend to move steadily, apart from the occasional shock like the coronavirus.

Stock prices move wildly from very low to very high because investor psychology deems those earnings more valuable at some points in time than at others.

This is the Mr. Market phenomenon you might have heard about.

Sometimes Mr. Market is grouchy and sad and offers you shares in stocks very cheaply because he just wants to get rid of them. That’s a good time to buy – you’re getting them cheap.

Other times, he’s giddy and feeling good, he loves his stocks and you’d better offer a high price if you want him to sell to you. These aren’t great times to be a buyer.

This cyclical nature of markets has always fascinated me, the psychology and herd mentality which causes more and more people to pay higher and higher prices for the same thing.

In cyclical terms, we have had a 12/13-year bull market, we are at the highest valuations that I’ve ever seen in my short career, and things like Gamestop and Dogecoin are bigger than Lloyds

With stock valuations at such highs, investors should be very afraid of a market crash.

At the same time though… inflation is also a concern of an opposite nature.

If a market crash takes valuations back down to a more reasonable level relative to the economy, inflation does the opposite. It helps the economy catch up with stock market valuations.

So it’s possible that over the next ten or 15 years, the stock market could go roughly nowhere (up a bit, down a bit, up a bit, etc), while prices rise – food, clothes, flights and the rest.

This would make GDP grow larger (“inflate”), shrinking the gap between stocks and the economy.

It’s like… if a ratio is 2:1, to make it even again you can either change the first number to a 1, or the second number to a 2.

If the stock market is twice the size of the economy, either the economy can double, or the stock market can halve. That would be the midpoint of the pendulum – a market cap-to-GDP ratio of 100%.

With extreme monetary stimulus, with commodity prices soaring, with savers fleeing cash for gold, cryptos and financial assets (showing a nervousness to hold cash), with CEOs talking about price pressures, and with bond prices moving to reflect higher inflation fears…

.. inflation of some sort, in some places, is looking likelier than ever.

If your investments don’t crash in value, maybe the value of your currency will (prices going up is the same thing as the value of a currency going down).

These two risks – inflation, or a crash – are the key risks facing investors today.

And as I see it, there is only one investment which offers some protection against both.

Gold.

(Miners and other precious metals play their part too.)

It is firstly a traditional store of value against the debasement of currencies, against prices rising, having been so for thousands of years.

Ten grams of gold will buy ten chocolate bars today and ten chocolate bars in ten years, whether those bars cost £1 or £100. The value of the gold stays roughly in line with the value of the goods – it’s the currency which changes.

But gold is also seen as a safe haven during market crashes, so investors sell their stocks and buy gold in times of trouble.

For example, on eight occasions where the S&P 500 has fallen by 19% or more since 1929, gold has shown a positive return in six of them.

Only in one did it underperform the stock market, between 1980 and 1982, just as Paul Volcker was coming in as Federal Reserve chairman to crack down on inflation.

Look, I’m not saying it’s the perfect asset or that it’s guaranteed to make you rich quick or anything silly like that.

But it’s like owning home insurance if you live on the coast in Florida.

Gold acts as insurance against downside risk in asset prices, and upside risk in consumer prices.

What strikes me as odd though, is how unpopular is.

I think of it as a natural and crucial part of any diversified portfolio – acting just like insurance.

But maybe because it has no yield, or isn’t a company. I don’t know, but very few fund managers or savers are keen on holding much gold.

I think that ought to change – and so do many of my colleagues.

That’s why they’re putting on a brilliant event – a Gold Summit.

And that’s why I’m inviting you.

It’s free – a series of brilliant guests talking through all the major issues and talking points with this crucial investment.

And I think it couldn’t be more relevant or more useful.

You can attend by simply clicking this link, and I urge you to do so!

You won’t regret it.

I hope you all have a great week tuning in to all the brilliant talks.

All the best,

Kit Winder
Editor, UK Uncensored

PS By the way, my colleague and editor over at Exponential Investor has put together a brilliant report on investing in the green transition. It’s completely free.

Click here to get your hands on it.

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