Valuation Mirages


3174917_sWe all have seen the familiar movie vignette of the lost man in the desert suffering from severe dehydration.  The scene is typically one of a man staggering across blistering hot sand dunes in tattered clothing while muttering to himself.

Far off in the distance he sees a vision of palm trees and a cool pool of water beckoning him.

An oasis!

He quickens his pace, excited that he has found his salvation.  After reaching the edge of the pool he dives in, only to be greeted with a mouthful of hot sand.

The mirage has struck again!

Unfortunately the current investment climate seems to reflect the familiar Hollywood mirage scene.

It’s sort of a version of “yield dehydration” that can cause hallucinations and erratic behavior amongst those searching for a return on capital.  Outside of the select few with access to the Fed’s discount window, the lonely retail investor stumbles across the barren investment landscape as he is tempted by several mirages.

Let’s take a quick tour of the most common investment options:

Cash – Good soldiers don’t die they just fade away

The above quote from General Douglas MacArthur describes cash pretty well.  Putting your capital in savings accounts/CDs has typically been seen as the safest investment.  Unfortunately, you are likely to witness its value erode over time.  With the Fed targeting inflation at 2% and typical savings/CDs well below this level you know your purchasing power is decreasing over time.

One of the central functions of money is a store of value.  Simply stated this is the idea that if one doesn’t spend money today he can hold cash and spend the money at a later date.  The current climate suggests that money not spent today will buy less in the future.  It seems cash currently produces a negative return.

Bonds – A spring under compression

When buying a bond you are lending the issuing entity money.  When lending money you must worry about several risks.  One of the most basic risks is interest rate risk.  The issue here is that interest rates are being held low..very low.. by the Fed as part of the effort to stimulate the economy.  No one knows when the stimulus will end and when interest rates will be allowed to normalize, hence the metaphor of a spring under compression.  When will the Fed let go and when will interest rates rise suddenly to reflect the realities of the market?

For example, one could buy a bond paying 2% today and find that in a short time interest rates have risen rapidly to say 4%.  What would that do to the value of your bond?

Real Estate –You don’t own the property; the property owns you

Some of you may remember the 1980s comedian Yakov Smirnoff who was famous for comparing Soviet Russia to America in his jokes and gags.  One of his most famous lines was, “In America you go find party…in USSR, the party come find you.”

So it is with real estate investment these days.  For those owing rental properties the initial visit to housing court is quite similar to finding out Santa Claus is not real.  The process of enforcing your property rights (the right to collect rents or evict) is byzantine at best and typically the end result is a significant period of lost rents.

In addition, property taxes have become so significant in some areas that the concept of property ownership itself is called into question.  Do you really “own” something if a significant yearly “rent” is due to the local municipality?

Commodities Futures – Trust is dead

No one seems sure about exactly what has gone on in the commodity markets lately.  From the commodity accounts at MF Global “disappearing” to recent allegations that some metal markets have been tampered with, an investor would be wise to be very cautious about investing in this area.

Money disappearing from commodity accounts or artificially high prices paid for commodity investments are not hallmarks of a fair and transparent market.

Stocks –Playing “Marco Polo” at the edge of a cliff

I am sure many of you are familiar with the children’s game of Marco Polo.  One child is blindfolded or closes their eyes and yells “Marco.”  The other children then respond by yelling “Polo!”  The objective of the blindfolded child is to tag the other children while being guided to their location by listening to the shouts of “Polo!.”

The equity markets have been on a tear lately, reaching towering highs.  Investors have been enjoying the ride so far following the market’s shouts of “Polo!” to ever higher destinations.  Unfortunately this game is being played at the edge of a cliff as the market’s highs have been encouraged by the Fed’s QE program.  The danger here is that one could find themselves following the shout of “Polo” and buying into the market only to realize that QE has ended or has “tapered” and the formerly solid ground beneath their feet has disappeared.

“So what are we supposed to do…nothing?”, moans the peanut gallery.  Another question might be how is today different from any other time in history?

Many of you may have noticed the common thread in our discussions of the various investments above.  Until the various attempts to alter market realities end, unscrupulous market participants are reigned in and property rights receive greater priority, investing will remain plagued by mirages.

Have a great week,

 

Michael Bechara, CPA, CFE, CRMA

Managing Director

Granite Consulting Group Inc.

mbechara@consultgranite.com

845-282-3899

 

 

 

 

 

 

 

 

 

 

 

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