Last weekend, Barrons conducted a roundtable on expectations for the year ahead. One of the best interviews came from Franklin Templeton Investments CIO Sonal Desai.
Desai is a terrific money manager. But what stood out in her conversation with Barrons is her humility. One thing that most managers don’t do is admit when their opinions are off. She came in with an interesting perspective.
Price Discovery Is Underway
Desai acknowledged that she anticipated a vaccine-induced economic boom, but it ended up producing a larger labor shortage than many expected. I can commiserate with this view.
She said that she dismissed supply chain problems and thought they would pass. But they haven’t (and she now projects they will last much longer). I’ve said that the supply chain issues are going to last all of 2022 and into 2023. We haven’t even gotten to the issue around the Longshoremen in California and their labor contract that expires in July. This could be a MASSIVE economic risk in the months ahead.
Third, she said inflation could last much longer. I agree. Fourth, she said that central banks are experiencing new leadership that could fuel big shifts in policy. Fifth, she acknowledged that China and geopolitical risks are likely to return to the market. I have echoed all three sentiments for a few months. But her final point is most important.
What She Said…
“My last point is that we have had more than a decade of low market volatility, largely because of the large amount of liquidity in the financial system. We are at the start of a multiyear period, if not a decade, in which the markets will have to learn to reprice risk, because the consequence of a decade’s worth of extremely easy central-bank policy has been the distortion of prices and the mispricing of risk. The coming period is going to be a difficult one. I anticipate a rocky multiyear adjustment period resulting from the combination of high valuations and the unwinding of central banks’ easy money that has distorted risk assessment and capital allocation in markets for over a decade.”
This is the argument that must be explored at greater length. For the most part, we’ve seen moves in the market around inflation, supply chains, and shipping.
But we haven’t experienced dramatic shifts in capital flows over “price discovery” – the process where the markets try to determine the real value of assets.
Where to Look
Last week, I highlighted a string of stocks with price-to-sales ratios over 30. These are extremely expensive stocks. In a world where growth stocks are discounted at zero percent interest rates, those stocks can go higher and higher.
But eventually, fundamentals will return to the market. And we are witnessing a significant outflow of capital from expensive tech stocks right now. This is evident in the performance of Cathie Wood’s ARK Innovation ETF (ARKK).
I think that Desai’s thesis above is the most important story for the markets over the next two years. In many ways, it mirrors the story of the Dot-com bubble. It isn’t history repeating itself, as much as it is rhyming. There is a reckoning ahead for these overpriced tech stocks that no longer justify their valuations when interest rates rise.
I would be VERY cautious as a tech investor and would instead focus on the companies that already have solid metrics in place. The cheap tech that value investors want to tackle exists. You just need to know where to look. We’ll dig into a new strategy for value investors in the coming weeks.