August 18, 2010
I’m a big believer that when someone tells you “It’s different this time” you should subtract their age from 100 to arrive at the probability they’re WRONG. When it comes to investing, experience and a solid knowledge of history is paramount. Markets are cyclical. Fear comes and goes. Exuberance comes and goes. Market crashes WILL happen. But fundamentals are fundamentals and in the long-run they WILL prevail. History proves this.
The trouble is knowing when normalcy will return. British economist John Maynard Keynes said it best with, “Markets can remain irrational longer than you can remain solvent.” My response to this is a buy-and-hold approach. I don’t pretend to know what will happen over the next several months. But my DCF models which incorporate normalized margins, realistic growth rates, and historically-based discount rates, allow me to confidently value a business’s cash flows to arrive a reasonable valuation.
Applying these techniques and logic to the Treasury market, I come to the conclusion it is irrational. With the 10 year hovering around 2.6%–its lowest rate in history—I fear fear has taken over. Check that, I KNOW irrational fear has taken over.
Some say it’s different this time. They point to the jobless recovery and dismal housing numbers. They harp on these figures but ignore the one great principal of investing—buy low and sell high. With the 10 year at an all time high, why on Earth are money managers chasing it? Especially when everyone knows inflation will exceed 2.6% over the next 10 years? It has to, doesn’t it? Over the past 50 years, U.S. inflation, as measured by the Consumer Price Index (CPI), averaged 4.1%. Over the past five, 10, and 20 years the average was 2.6%, 2.6%, and 2.8%, respectively. So, unless you think we’re in for something “different this time”, the 10 year is a colossal value trap.
It’s never different this time. It’s just that the time it takes to return to equilibrium varies. Stay patient, don’t panic, and don’t follow the crowd buying Treasuries off the cliff.
