Smart Capital looks for the Highest Return at the Lowest Risk
During the financial crisis of 2007, a lot of stock market value just vanished as investors panic sold. It should be understood that mature investors who remained calm and patient experienced even larger gains in the years after the financial crisis. Some stocks, of course, didn’t recover but most did and surpassed the previous highs.
Many investors dumped stocks and moved to cash. This move also comes with twofold risk as you would have to be right on your risk analysis twice in a row for it to pay off. As an example, you would have to time your move out of stocks and into cash just right to maximize gains and minimize losses. But you would also have to time the move out of cash and back into stocks just as accurately. Most investors would have been better off holding through 2008 and 2009 to ride the wave back up to higher gains.
Gold and other precious metals experienced a bull run after the crisis but have since plateaued within a realistic range over the past few years as the Feds normalization of monetary policy ensues. We are now in an environment where interest rates are increasing and the Feds balance sheet normalization is being increased from $30 billion a month to $50 billion a month.
There is no doubt that the Feds increased balance sheet under QE had a lot to do with the increases in the stock market in the years after the financial crisis. This is not disputed. It would stand to reason that a reduction in the balance sheet would have the reverse effect on the stock market. But it’s not that simple.
During the years of the crisis, there were stocks which experienced double-digit gains while everything else was tanking. All of these companies had one thing in common, which was a high Return on Investment Capital, or ROIC. The smart investors understood that during times of crisis and panic the fundamentals matter. Companies which were managed efficiently and effectively could provide a safe haven from the storm. Safe havens become valuable.
Another fundamental is that decreasing interest rates make money cheaper and will lead to an expansion of the money supply. Increasing interest rates make money more expensive and will contract the money supply.
So we are now a few years into a trend of Fed balance sheet normalization and increasing interest rates. The stock market has been up and down this year but hasn’t achieved any substantial net gains. Should we consider that the smart money is attempting to build a path out of stocks and into an alternative?
Unlike in 2007 and 2008, where cash, gold, and companies with a high ROIC, were the only real alternative investment vehicles, today we have a crypto market which has been busy building the architecture and pathways for massive institutional and private investment. The flow of capital needs to be controlled and directed through the new crypto architecture to ensure value is transferred as opposed to lost.
This is not to say that all stocks will drop. Some, like before, will increase in value. There could even be some crypto companies, like Ripple, or exchanges like Coinbase, that could have IPOs. This would provide a double crypto opportunity as capital would flow into both crypto assets and crypto companies which are leveraged to benefit from the growth of the market.
As previously stated, the 3rd quarter of this year will see the Feds balance sheet being further normalized by an additional $20 billion a month. Plus, there will inevitably be further interest rate increases between now and the end of the year. This will put additional pressure on the stock market.
But don’t expect a stock market crash. Nothing that dramatic will happen. There will be an orderly flow of capital from one to the other with some stocks doing fantastic and others fading away. The huge profits which will be made in the crypto market could even flow back into stock markets and those companies which are well positioned with low debt and high ROIC.
There will even be an eventual and temporary equilibrium between the two markets as the wealth distribution begins to balance and settle down. It may take years to reach that point and in the meantime, there will be opportunity for the astute and patient investors. The next phase will see a larger adoption of company based tokens which will replace stocks. We can see that this is already starting as companies such as Kodak have developed their own token. But there’s much that needs to happen between now and then.
Capital looks for the highest returns at the lowest risk. The crypto market is almost at the tipping point where it is just as appealing, or more appealing, than the traditional stock market. The next few months of summer, and leading into the fall, will be fascinating as large amounts of capital begin to flow through new corridors. – JC
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JC Collins can be contacted at email@example.com