FWIW # 12 Store of Value January 2021

What is store of value?

The operative phrase in the investment markets today is store of value. Everybody is looking for a place where they can put their assets and have stable purchasing power in the future. A store of value is as elusive as a free lunch. Visually imagine an asset remains at a fixed price while the currency devalues, so at any point in the future, the asset can be sold for a greater amount of the less valuable currency, effectively buying other assets at the same parity as before the currency declined. Remember this definition of store of value because it is important. As with many definitions in finance, the current participants change many definitions to suit their wants.

Which assets are stores of value?

Today advocates of all asset classes espouse their favorite class as a store of value. To the above definition, they have even added that their concept of store of value is inversely correlated to the stock market, or real estate, or whatever comparison they choose at any moment. They will point to a relative change in value of their favorite asset as proof of its store of value. These speculators are confusing changes in supply and demand for the true store-of-value characteristic. Very few, if any, assets don’t have a period when they outperform or underperform all other assets. Why? Supply and demand for the asset.

Here’s the ugly secret: There is no asset that is a store of value in and of itself. All assets are stores of value if obtained at the right price. No asset is a store of value if obtained at the wrong price. Speculators will say fixed-income securities are not stores of value. Really? Tell that to an investor who put money in 30-year U.S. treasuries at 14%-plus in 1981. Inflation during the 30-year period that bond was in existence averaged 2.66%, giving the intelligent investor in 1981 a handsome real rate of return and a store of value for 30 years. Certain commercial and residential real estate is a store of value over time when the demand for its location increases due to population growth. With all real estate, it is crucial the property’s income can offset the three negatives about owning real estate: maintenance, taxes, and insurance from all hazards. These are costly expenses many speculators don’t think about when comparing the purchase price to a future price. When the real estate is in an expanding area and generates steady and rising income to exceed these costs, it has the potential to be a store of value.

Some common stocks have the potential to act as stores of value for long periods. Stocks represent companies that are functioning economic entities. There are three potential outcomes for any company: (1) It can dissipate its assets and ability to earn money over time; (2) it can maintain its niche in the economy, staying relatively stable in revenue and earnings, nominally growing through inflation caused by a depreciating currency; or (3) it can increase its revenue and earnings faster than the currency depreciates and increase its share in its marketplace. Obviously, companies in the first category cannot be a store of value for any period since their stock is a wasting asset. Stocks in categories two and three could be stores of value or not. Why?

In both categories, there are measurements that can determine the relative value between the price of the stock and the current assets/earnings of the company. Therein is another secret of store of value: the relationship between the value the investor receives and the cost of the stock. If an investor receives assets and earnings for a fair price, there is store of value. If the stock pays a dividend, the store-of-value aspect is greater since the dividend will offset some or all of the persistent real inflation. Companies that increase their dividend payout over time further strengthen their shares’ store of value. Another factor impacts the store-of-value characteristic: The demand for the stock will ebb and flow. When demand increases for the shares, the difference between the underlying current assets and earnings and the stock price widens, reducing the store-of-value aspect for new speculators while strengthening it for the investors who bought the stock at the correct relationship.

The same concept works for any asset class: Buy the asset when the price is close to the current value and income stream and the store-of-value characteristic is strong. Rationalizing the price paid by comparing it to nonexistent potential revenue and earnings erodes the asset’s long-term store of value. Wall Street works by doing just that: trying to guess the future. This is the point when someone will say Tesla, Amazon, Apple, etc. are proof the store-of-value perspective is wrong. No, they aren’t. All the current craze for market leadership proves is the law of supply and demand. When there is more demand than supply, the price of anything will rise. When demand decreases or supply increases, the price will fall even faster than it went up. Until the lack of demand or the increased supply drives the price toward the current assets and earnings, the store-of-value factor will not be obtained.

Let’s look at the markets to see if store of value is even possible for an investor today.

Which markets allow for a store of value?

The investment markets have reacted to the COVID-19 pandemic unlike most people would have expected. After an initial collapse, the stock market came roaring back, led by the same technology stocks that were leaders before the virus hit, along with companies that would benefit from consumers staying at home. Demand for the obvious has driven most share prices away from current assets/earnings into the area where the nonexistent potential revenue and earnings must be extraordinary or else serious trauma will befall the speculators.

There is no store of value in investment-grade fixed-income securities since the returns on these securities are artificially suppressed by the Federal Reserve (Fed). The next potential financial crisis will likely be in fixed-income securities as the depreciating currency removes the Fed’s ability to suppress long-term (10 years or more) interest rates and the marketplace begins setting rates.

Real estate is a mixed group. Homes where people can upgrade their circumstances or get away from an urban environment have accelerated in price due to increased demand. Urban residential and commercial real estate are under price pressure due to lower demand. The lower prices give a potential for investors to find store of value.

Alternative investments, led by Bitcoin and other digital-age facsimiles of investments, are soaring from extraordinary demand caused by TINA, FOMO, and IIDTT (See FWIW #11). Diverting slightly from store-of-value discussion, the U.S. government announced November 20, 2020, that law enforcement had seized $1 billion worth of Bitcoins (today worth $2.5 billion if they still have them). They did this through tracing Bitcoins belonging to a criminal organization in 2015. So much for confidentiality and store-of-value characteristics of cryptocurrencies.

Common stocks are at all-time highs. The relationship between current assets/earnings and share prices is completely severed for most sectors and companies. Everyone has their eyes set on assets/earnings two, three, and even five years from now to justify stock prices. No one knows the future. Who could have predicted on January 1, 2020, what would happen after that date? Market hysteria is a combination of the above factors affecting alternative investments, plus aggressive borrowing by speculators to buy stocks, IPO and SPAC hype, and the irrefutable fact that governments around the world are systematically and in a coordinated way depreciating all legitimate currencies. The Fed, Wall Street, and the media misrepresent the truth about underlying inflation and its increasing destruction of the U.S. dollar’s value. This last factor is critical to understanding the struggle coming in all investment markets, as well as at what level common stocks will offer a store of value.

Speculative hysteria is screaming warnings at anyone willing to hear. The margin borrowing to buy stock is at an all-time high. The market leadership is shrinking. The small stocks are accelerating faster than the larger companies, and individuals are speculating with as little as five dollars. When the tipping point will be reached is unknowable. That it will be reached is knowable. The pressure on the markets will be challenging, driving share prices back into a sensible relationship with current assets/earnings thus offering store-of-value opportunities. How much lower than current levels will that be? It depends. One concept is for sure: Selling a long-term common stock position to avoid the market volatility is a mistake.

What should investors do?

Downward stock-price pressure will be huge. When all the speculative excesses are crashing, there will still be one major source of support for the market: The currency destruction by central banks will continue unabated. As a matter of fact, the destruction could accelerate as incompetent politicians call for more stimulus. Smart investors know the only liquid stores of value are companies in categories two and three above. Serious investors will be ready to shift monies from other assets (such as money market funds and short-term treasuries) into companies in these categories as prices decline towards store-of-value levels. The time to prepare for this event is now. Find companies that fit both categories, determine an intelligent current asset/earnings relationship to price, and select the companies that make a portfolio more balanced and generate more income, thus improving the portfolio’s store of value. The results will be worth the effort.

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