FWIW # 56 - Answers and Importance of Know What You Own

Now we know the reason for the market decline. The war with Iran confirms many beliefs. First, the world has changed to the extent critical geopolitical issues are no longer being kicked down the road by politicians unable or unwilling to make tough decisions for the safety of the country. Second, the dumping of stocks in the past few weeks was not about AI taking over software. That was just the know-nothings making excuses for the volatility to look like they were smart. Third, don’t ever believe that insider information doesn’t exist at the highest global political levels. There’s nothing you can do about it, and in most instances, it’s irrelevant to a long-term investor. Fourth, market volatility makes it even more important to know what you own.

What is meant by “Know what you own”? This question is asked over and over again. Along with it comes the saying, “I own XYZ index fund or ETF, so I know what I own.” That’s not true. A speculator who owns an index fund or ETF just thinks they know what is in the fund or what the manager or Aps (Authorized Participants are institutions allowed to create or redeem shares of an ETF) will do in the future. Just look at what is going on right now in the stock market. As stated above, this high velocity is not driven by AI threats to software firms or any of the other made-up reasons touted by the media and their puppeteers on Wall Street. Do you really think it was just last week that someone realized AI would have an impact on software stocks? That’s not even logical. In addition, when stocks fall 5%–15% in a day or a week, do you think it’s just retail speculator selling? No.

What’s Really Going On

Some very large institutional speculators, perhaps hedge funds, insurance companies, pension managers, and/or sovereign wealth funds, have been liquidating stock positions without concern for the price they receive or the liquidation’s effect on the share price or market. While some of the money is being rotated to undervalued sectors, much of it is going into the US Treasury market. The US–Iran conflict is evidently the main catalyst for the selling. There were reports last week that Iranian government backers were sending huge sums of money out of the country, so it’s unlikely the regime will be able to fight the coalition and internal insurgency for long.

            The growing implosion of private credit, in my professional opinion, will deal a second blow to the stock market. Why? Because private credit touches just about every aspect of the financial markets and related private equity markets; it’s a sector under its own valuation pressure. Don’t forget hedge funds are in the private credit arena. The regulated banking sector is there also, lending money to the private credit managers who then leverage their investors’ capital. Keep in mind the old Wall Street adage: In time of crisis, sell what you can even if you can’t sell what you should.

Learn from History

When psychology is normal or positive, it’s easy to say discipline will rule and a speculator won’t succumb to the hysteria of fear. But is that really true? Think back to when the entire market thought oil and gas usage had peaked. The stock market believed the oil price was going down, and it plunged to single digits and oil stock prices collapsed. Or remember when the entire world believed the supply of oil would be cut drastically? Or, in the last few weeks, the hysteria that AI will take all white-collar jobs away and put software companies like IBM out of business? In moments of fear or greed, psychology will crush many speculators’ discipline, particularly if they are professional managers whose livelihood, mortgages, and high-maintenance families are at risk if the manager doesn’t move with the crowd. Market professionals are more susceptible to fear and greed than novices.

            Remember, a stock’s price has two components:

1. the value of the company’s franchise, including assets less liabilities and earning power
2. what speculators believe is the future of those assets’ earning power

Market speculators look at the potential growth of earnings and the capitalization rate of those future earnings. The first basic principle you should know is that the company’s fundamental operating ability to increase sales and earnings is usually limited. So, when a market or the price of a stock rises fast, as we have seen since 2009, the overwhelming component of that rise is market speculators expressing optimism about future sales and earnings increases. A positive outlook on the economy’s growth and the inflation rate, which eventually boosts the asset and earnings value of a company, are other examples of speculators anticipating the future. The ride up is wonderful as stock prices race ahead in a bull market. But eventually, just as night follows day, a bull market is followed by a bear market. In a down market, speculators turn pessimistic and sell without concern for the underlying value, even if, over the bull market years, the fundamental value has increased.

Know What You Own

Here’s why we say to know what you own: If you own the S&P 500 or any other index, you don’t know how speculative fear will affect the index holders in the short run or the long run, or when the index manager may sell quality companies for a number of reasons. Forced selling by index holders, managers’ fearful reactions to news reports, or any number of issues, depending on the psychological profile at the time of the bear market, will cause indices’ liquidation. As an example, remember the ESG hysteria that had institutional speculators eliminating or bypassing energy stocks, only to start buying them years later at three and four times the price, when the stocks showed the best upward momentum.

If you own individual companies that you or your portfolio manager selected, you can look at them and know they will continue to be an ongoing business in the future since they have been through economic crises in the past and continue to meet their customers’ wants and needs. You will resist the fear hysteria gripping those who don’t understand the true point of the stock market is to own a piece of the US and global economy, not to worry about price volatility. If the price swings get extreme, more good companies can be bought at fair prices with good dividends.

            Finally, pray for our service personnel in harm’s way. Hope for a quick conclusion; however, be realistic and know the Iranian regime has planned for this war for decades. There will be good progress and shockingly bad setbacks.