Reader Mailbag, November 2024 Edition

Folks, we have officially reached the news lull—that quiet patch between the election and Thanksgiving where headlines rehash old news and everyone is quietly gearing up for turkey, stuffing, cranberry sauce and sales. So, what better time to check in with you and provide some As to your Qs?

What are some of the risks to the global economy?

In general, and we aren’t assigning probabilities here, risks include major monetary policy errors, a credit crunch that catches folks off guard and businesses’ getting too far out over their skis.

If this list looks familiar, it is because these are big perpetual risks. Central banks can always over-tighten and over-loosen. If banks get risk-averse and focus on deleveraging rather than lending, then it can starve the economy of the credit that fuels investment and growth. And if businesses get too bloated, spending too much money on projects that won’t pay off, it will set the stage for a recession to rein in that excess.

Now the good news is, we don’t see any of these existing or forming at this moment. Perhaps there will be more to say on this front when we share our 2025 forecast in a few weeks. But central banks don’t appear to be going overboard in either direction, lending appears to be mounting a recovery from a weak patch, and businesses are being pretty judicious with investments. However, we are watching things carefully—especially knowing traditional dashboard indicators like the yield curve and Leading Economic Index are less effective right now, with COVID-related dislocations still disrupting things a smidge. So we are being vigilant and doing a full engine diagnostic. Again, for now it looks good, but stay tuned.

Where are some opportunities for positive surprise?

In general, wherever sentiment looks too low, the potential for positive surprise lurks. Now, this isn’t a formal forecast of relative returns over the period ahead. But in terms of places where sentiment looks needlessly depressed, Europe is a big one. The gloom over Germany’s government collapse and weak economy, Britain’s fiscal policy and France’s debt looks overblown to us, and reality looks quite likely to exceed expectations. It may not translate to big outperformance, as industry/sector/style trends have a great influence on relative returns, but in terms of pure surprise potential, that strikes us as one. If you read the headlines and see where sentiment looks most depressed, this is a good place to start.

What should I tell my friend who has an opportunity to invest in [unnamed non-public company]?

Look, this isn’t investment advice because we don’t know the individuals involved. It is an article, and an article isn’t advice. And we don’t make individual security recommendations. But we do have some opinions on the general theme of investing in non-public stocks, things we think anyone should consider carefully.

Liquidity is a big one. Companies are staying private for eons these days. If there is no liquidity event in the next several years—no buyout, no IPO (initial public offering)—and therefore no opportunity to get out if necessary, will this be a problem? Access to funds is a crucial issue, and if having money locked up in something unsellable is going to be a problem, especially in a potential emergency, this is something to weigh.

Think, too, realistically about the potential return. In our experience, and we aren’t saying this is necessarily your friend’s mentality, people tend to view pre-IPO stocks as a rocketship to big returns. We have all seen the big IPO success stories, and getting in well before the IPO seems like a smart way to play it. After all, we like to quip that IPO stands for It’s Probably Overpriced—but if you can get in at a lower valuation before the IPO, then suddenly you are the one potentially benefiting from that overpricing.

But test that theory against the real world. For every sky-high IPO, there is one that missed expectations, languished or even crashed. And not every private stock even makes it to IPO town. Many fail. Some get bought, and the early investors get either cash or stock in the acquiring company. In this transaction, you are at the board’s mercy, and if you think the acquisition price is too low, tough beans.

The opportunity cost here is potentially massive. Let us say, as a simple hypothetical, that there is an opportunity to get in on a hot startup at a dollar a share. 10 years later, it finally gets acquired at $5 per share. That isn’t what you were hoping for, but it is still a 400% return, hip hip! But what if global stocks return, say 500% over that same decade? Or 600%? Was it worth the lack of liquidity for an inferior return?

And this is all before we get to individual security analysis and weigh the business model’s soundness, whether revenue projections are reasonable, long-term industry trends, competitors, leadership and all the other nitty-gritty things one must weigh when selecting individual stocks. Again, we aren’t doing that advice here or making a recommendation. But it is important to think clearly and objectively about.

I’m thinking of investing only in non-US stocks. Your thoughts?

First and foremost, we would flip this around and ask, why? What is the motivation here, and is recent past performance at all a factor? We ask because we have seen all the headlines arguing US stocks have come too far, too fast while Europe is relatively undervalued. It is this weird cousin of heat chasing, and it often catches people out. One, the thesis tends to be too well known not to be priced in. And two, valuations aren’t predictive. As we touched on earlier this week, cheap stocks can get cheaper and expensive stocks can get pricier. Valuations say how much people are currently willing to pay for future earnings—not how much they will be willing to pay in the future.

So if you are influenced by past performance, we would suggest this isn’t a good reason for such a major portfolio overhaul.

Beyond that, finance theory tells us that in the very long run, all similarly broad and well-constructed benchmarks should end up in more or less the same place. So over the long haul, and we are talking decades here, US and non-US stocks should probably deliver comparable returns, provided you are using broad indexes (S&P 500, MSCI World Ex. USA) to gauge it. Over a long enough timeframe, all the currency, sector, industry, style and geographic trends that can affect relative returns in the short term should even out. Now, it is possible and easy to cherry-pick long periods where this does and doesn’t hold true, but as a theory, we think it is a sound guide.

So the main question is, how much volatility are you comfortable with? The US is about 70%, give or take, of MSCI World Index market capitalization. Losing the US means losing diversification, not just at a geographic level but at a sector- and industry-level, too. Europe has much less Tech and Tech-like companies, for instance, and tilts more to value-heavy industries. This means a non-US portfolio will probably have less smooth a ride than a fully global portfolio. That could manifest in more ups and downs. Or long periods of both leadership and underperformance. Maybe you think this is a fine fit for your goals. Maybe not.

But again, if this question is inspired by a desire to time shifts in relative returns, we don’t think ditching the US is the answer. Humility is one of an investor’s greatest assets, always. Remember you could always be wrong, and structure a portfolio so that it will benefit from the trends you are wrong about as well as those you are right about.