“Money is of a prolific generating Nature. Money can beget Money, and its Offspring can beget more, and so on.”
– Benjamin Franklin
As noted by Ben Franklin, money is a dynamic creature. Like history’s most influential thinkers, Franklin’s wisdom was pure common sense. In his day, industriousness, frugality, and longevity were the keys to financial health. Albert Einstein is another example of such down-to-earth logic when it came to the pursuit of wealth. He once observed that “Compound interest is the eighth wonder of the world. He who understands it, earns it, he who doesn’t, pays it.” What else do investors need to know? Nice, but life is not so simple. People tend to be irrational and illogical, especially when money is involved. The brilliant Sir Isaac Newton lost a fortune in the South Sea Bubble. His most famous quote is, “I can calculate the motion of heavenly bodies, but not the madness of people.” Mark Twain repeatedly fell victim to various “can’t miss” swindles. Successful investing has little to do with intellect and everything to do with discipline and patience.
Why Interest Rates Matter
We bring up this subject, because while the U.S. stock market rallies skyward, investors are taking on more risk. The dog days of August are here, but the players in politics and finance remain focused on the trends of inflation, jobs, and the Fed-funds rate.
Weakening employment data has put a September rate cut by the Federal Reserve back on the table. The White House continues to evaluate candidates to replace Fed Chair Powell, promenading them out like contestants in a beauty pageant, and Wall Street cannot wait to find out who will wear the crown. Meanwhile, asset-price inflation has soared – thanks to abundant liquidity. Easier monetary policy is likely to encourage additional speculation and elevate risk.
Financial historian Edward Chancellor has authored an excellent book titled The Price of Time – The Real Story of Interest. Chancellor writes that:
“Interest – the time value of money – lies at the heart of valuation. Interest is required to direct the allocation of capital, and that without interest it becomes impossible to value investments. Interest incentivizes saving. Interest is the cost of leverage and the price of risk. When it comes to regulating financial markets, the existence of interest discourages bankers and investors from taking excessive risks. On foreign exchanges, interest rates equilibrate the flow of capital between nations. Interest also influences the distribution of income and wealth. A very low rate of interest may benefit the rich, who have access to credit, more than the poor.”
Please do not misunderstand. Capitalism is our religion. Nothing beats a market-oriented society. The point is that the trend of interest rates affects assets much more than the real economy. A lower Fed-funds rate may juice the stock market but also encourage reckless speculation. Judging by historical metrics, U.S. indices are already expensive. For example, the price/earnings ratio of the S&P 500 is 23 on a forward 12-month basis – a 21% premium to its 10-year average. Unfortunately, valuation is a lousy short-term indicator. During bull cycles, key price gauges become costly and can remain so for extended periods. The moment to be extra careful is when everyone is behaving more like Sir Isaac Newton than Ben Franklin.
Meme Trades, Margin Loans, and “Deversification”
Right now, the betting window is wide open, and folks are living large. Here is the evidence:
- Meme trades are back. Check out the charts of BitMine Immersion Tech and SharpLink Gaming. “YOLO dude!”
- 464 new exchange traded funds have been offered year-to-date. Hard to believe, but ETFs already vastly outnumber individual stocks. “Deversification” as opposed to ‘diversification” is the newest fad in the ETF world. New funds tracking the performance of a tiny sampling of stocks and sometimes only one are being packaged. These are higher risk bets, often leveraged, not to be confused with ETF’s original purpose -indexing.
- Investors are taking out big margin loans rather than realizing gains to generate cash. These loans now exceed $1 trillion.
- New blockchain platforms are planning to sell digital tokens mirroring the price tag of private shares such as SpaceX’s. The buyer does not receive an ownership stake. These tokens are in effect notes that ensure payment if the value increases due to an IPO or buyout.
- Robinhood is trading tokens representing shares of public companies like the high flying Nvidia. This is the good old bucket shop model.
Speculation, Status and Showmanship
- The number of U.S. billionaires has risen 50% since 2015.
- Recent articles in the Wall Street Journal: “Private-Jet Money Is New Wealth Yardstick,” “L.A. Is Going Nuts for a $33 Smoothie.”
- Conspicuous spending is the “new normal.” The most sensational article is “Superrich Buy Rolexes, $650 T-Shirts in Bulk.” The beautiful people are stocking their multiple residences and yachts with their favorite accessories. An interviewee commented; “I don’t know anyone who likes to pack, no matter how much you travel, no matter how many assistants you have. It is a pain.” You know – one can never have enough $600 jeans. Sounds like a character on HBO’s Gilded Age.
- Jane Birkin’s original prototype bag sold for $10.1 million at a London auction.
- Out of the goodness of their hearts, firms like KKR, Blackstone, and Apollo are opening private equity partnerships to retail investors. Blackrock intends to make private markets a significant percentage of total revenue. Nothing like an additional source of management fees to inspire goodwill.
- 351 members of the S&P 500 index are reporting non-GAAP accounting numbers. 89% of them adjusted their results, making things appear better. These non-GAAP earnings ignored amortization of intangible assets, serial restructurings, currency volatility, and other inconvenient truths.
- A 23-year-old social media influencer covering AI, raised $1.5 billion to start a hedge fund. He has no previous investing experience.
- The headline on the current cover of Forbes is “Crypto’s Second Revolution.” No comment…
- A growing number of companies, both public and private, are raising capital and using the proceeds to purchase crypto currencies. This practice is known as ‘the bitcoin treasury strategy.” Time will tell.
- Crypto exchange operator, Bullish, just completed an initial public offering. The shares were offered at $37, opened at $90, spiked as high as $118, before closing at $68. And they say markets are efficient…
- The U.S. has become a gambling culture. According to a recent poll by Siena College, 50% of American males have an account with a digital sports-betting book. More reason for Withum Wealth to preach the power of honest compounding.
- The specter of AI lingers in the political, financial, economic, and sociological backgrounds. Technological innovation has produced booms – think the steam engine, railroads, electricity, autos, telecommunications, computers, and the internet – also the occasional bust.
Back to the Basics: Compounding and Patience
Legendary investor John Templeton once made the timeless observation: “Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.” It is remarkable how rapidly sentiment has evolved since April’s “Liberation Day” panic. Our sense is that the environment is now optimistic verging on euphoric. In the months ahead, you may overhear bragging about quick wins in a variety of assets, especially if the Fed steps on the gas. Withum Wealth’s mission is to maintain the compounding power of your money. Losses triggered by greed produce setbacks that take years to overcome. Whatever happens, avoid being jealous of friends that seemingly live on easy street. Try to remember this quote by Warren Buffett’s business partner Charlie Munger: “Envy is a stupid sin, because it is the only one you could never have any fun at.” Munger modeled his entire life around Ben Franklin’s philosophy. We cannot imagine a better example of compounding.
