Stock markets in North America, Europe and the Far East were in a major funk throughout the fourth quarter as the mood of market participants remained decidedly negative. Few portfolios were immune from this malaise — including those we manage. When the market’s mood turns strongly negative and participants are selling with abandon, the prices of good companies are affected.
It is natural to be concerned about the health and safety of your portfolio in this environment and wonder whether your “nest egg” is secure. We thought therefore, that this might be a good time to reiterate our views on the subject.
Comparing Apples to Orchards
To determine the best way to protect your wealth, it is helpful to understand the difference between money and wealth.
Money is a medium of exchange. That means that someone who has money can exchange it for a product or service at a determinable rate — its price. A dollar has no value in and of itself — it has no “intrinsic” value. In the U.S., it’s just a piece of printed paper. In Canada, the loonie is made mostly of nickel which, at current prices, might be worth a few cents. We have all implicitly agreed, however, that we will accept dollars in exchange for our products or services, confident that we in turn, can exchange those dollars for other products or services.
Wealth on the other hand, is the ownership of an asset or ability that has the capacity to produce more wealth. If you own a widget-making machine and produce widgets that can be exchanged for more money than you spent to produce them, you have wealth. The value of your wealth is measured by the money you will receive for all the widgets you produce before the machine wears out. If you want to maintain or even increase your wealth, some of the money you receive for your widgets must be re-invested to maintain your existing machine or to acquire more widget-making machines.
Money in its various forms (cash, bank deposits, treasury bills, bonds) is often seen as a safe form to keep one’s investments. However, short-term bonds and cash yield a negative return after inflation and it is worse after tax is applied. Corporate or longer-term bonds offer higher (but still taxable) yields that may not compensate for the additional risk being assumed. Spending some of your money to support your lifestyle just accelerates the gradual depreciation of your holdings.
Gold is often touted as a safe haven but gold is just another form of money. It has little or no intrinsic value, only a price at which it can be exchanged. As a form of money, it has the advantage that it cannot be debased by the whims of governments since the supply of gold is relatively stable compared to growth in the global economy. It is, however, subject to wide price fluctuations that are often driven by fear or greed. It’s interesting to note that this has not always been the case. The massive influx of gold and silver from the New World to Spain in the late 1500s and early 1600s led to substantial inflation at the time (and consequential fall in the metals’ prices) and is considered to be a major contributing factor in the Spanish crown’s recurring bankruptcies in the latter part of the 16th century. It’s been said that the Conquest left Spain with a lot more money but not much more wealth.
The fundamental advantage that wealth has over money is wealth’s ability to be self-sustaining and to grow. If you own baskets full of apples, you can eat one whenever you wish and may be able to trade some for other necessities. Eventually you’ll run out of apples. However, if you own apple trees, you will never go hungry.
In order to keep the wealth you have and to create more of it, it is necessary to own productive assets — to own a business. A business results from the application of labour and capital to an enterprise with a view to profit (“profit” being the new wealth created). Of course, the opportunity for profit also brings with it the risk of loss but this can be reduced by introducing a degree of diversification (the appropriate amount of diversification is a topic for another day).
Fortunately, our system of public stock markets provides a mechanism for investors to apply their capital to the acquisition of shares of a wide variety of productive businesses. The only labour required is the ability to analyze the underlying businesses, to assess the business risks against the potential rewards, to determine a fair price and to monitor the progress of the business against expectations. If an investor doesn’t have the time, skills or interest in applying his or her labour in that way, the expertise can be purchased (a service which Genova is happy to provide).
Although the availability of the public stock markets is tremendously advantageous, it also has the feature of being an open auction system, whereby varying prices are applied to shares every day. Sometimes the price reflects a rational assessment of the value of the underlying business but often the price reflects an overconfidence or fear (sometimes based on geopolitical or macroeconomic factors) that is only indirectly related to the number or the price of widgets a company can sell. While the public markets provide liquidity for an investor and the inherent volatility can be an advantage when trying to buy or sell specific shares, it can also be disconcerting when prices are in broad decline.
At times like that it is important to keep in mind that it is the productive capacity that you own through the shares you hold, which defines your wealth. That has changed little, if at all, with the recent volatility. Now is a great time to review your portfolio to make sure you own assets that will continue to be productive even if the stock price has changed. Remember that the success of your portfolio is ultimately driven by the success of the underlying businesses you own, not the quoted price of the shares on any given day.
We are pleased to share our latest results. In the table below, we have outlined Genova Private Management’s compound annual returns (net of fees) for periods ending December 31, 2018.
Investing like an owner continues to deliver long-term value for our clients.