Investing has often been likened to chess – a strategic and patient game where one must anticipate the market’s next move. However, Cole Smead, the CEO of Smead Capital Management, paints a contrasting picture. To him, today’s investors might as well be in a “Barbie”-themed fantasy, blissfully ignoring the looming threats of inflation and escalating interest rates.
It’s not hard to see his point when you note that a risk-free 5.5% return is now achievable with 3-month Treasury bills. And yet, the stock market is behaving as if it’s still the belle of the ball, without considering the allure of bonds and their lesser risks. Cole observes, “When short-term rates soar over 500 bps, it’s a clarion call that investors should be recalibrating their asset valuations.”
Nevertheless, Wall Street seems to be dancing to a different tune. The S&P 500 has leaped by 16% and the Nasdaq Composite has skyrocketed by a staggering 32% this year. What’s fueling this exuberance? A bubbling optimism about the future of artificial intelligence and a hopeful wager that the Federal Reserve will reign in inflation without plunging the nation into a recession.
But, as with any high, there’s the inevitable come-down. Last summer bore witness to a nerve-wracking inflation rate of 9.1%. The Fed’s reaction? Cranking up interest rates from nearly zero to just above 5%. It’s been a move that’s eased the rate of price growth, bringing it closer to its 2% target. But there’s a downside. Inflation, as Cole analogizes, acts like “gravity” on stocks. If it were to edge up to 4% or 5%, the Fed’s reaction might be swift and significant.
In Cole’s view, many investors are donning rose-tinted glasses, or perhaps “Barbie” sunglasses. They’re neglecting to factor in the potential rate hikes that inflation could instigate. He cautions, “Stock enthusiasts might just be dwelling in a make-believe world.”
Adding a touch of sartorial flair to his warning, Cole suggests that investors might want to rethink their expectations. High yields might not be the stilettos of the future, but rather the practical flats.
The cautionary notes don’t end there. Bill Smead, the chief investor of the fund and Cole’s father voiced even starker concerns earlier in the year. Drawing a parallel to the dot-com bubble, he highlighted the unchecked enthusiasm for AI, predicting a potential sharp and painful correction.
In his words, “The current euphoria has soared to such a dizzying height that it makes the dot-com era seem quaint. Manias, as history shows, often come crashing down.”
For investors, these are words of caution. While optimism is a key component of market dynamics, so is pragmatism. Being aware of potential pitfalls can be as crucial as recognizing opportunities.