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Stocks are still the only way to get a reasonable income and growth...

February 07, 2022
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In this commentary, I am going to share opinions from two very respected pundits in the industry and then I will continue with my commentary:  

The Berkshire Hathaway CEO, Warren Buffett dismisses the idea that volatility represents risk. Stocks are more volatile than cash or bonds, but they're safer to own in the long run, Buffett says.

The billionaire investor and Berkshire Hathaway CEO has argued that owning stocks is safer than holding cash or bonds in the long run, even though share prices move a lot more. He's also ridiculed the use of volatility as a measure of risk.

Here are 8 of Buffett's best quotes about volatility, lightly edited for length and clarity:

1. "As an investor, you love volatility. You love the idea of wild swings because it means more things are going to get mispriced." (1997)

2. "The true investor welcomes volatility. A wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses. It is impossible to see how the availability of such prices can be thought of as increasing the hazards for an investor who is totally free to either ignore the market or exploit its folly." (1993)

3. "It doesn't make any difference to us whether the volatility of the stock market averages 0.5% a day or 0.25% a day or 5% a day. In fact, we'd make a lot more money if volatility was higher because it would create more mistakes in the market. So volatility is a huge plus to the real investor." (1997)

4. "Erratic markets are ideal for any investor — small or large — so long as he sticks to his investment knitting. Volatility caused by money managers who speculate irrationally with huge sums will offer the true investor more chances to make intelligent investment moves. He can be hurt by such volatility only if he is forced, by either financial or psychological pressures, to sell at untoward times." (1987)

5. "If the investor fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things." (Buffett argued that holding currency-denominated assets such as cash or Treasury bonds, which have their value eroded by inflation over time, is riskier than owning stocks for the long term.) (2014)

6. "No one ever gets that in a private business, where daily you get a buy-sell offer by a party. But in the stock market you get it. That's a huge advantage. And it's a bigger advantage if this partner of yours is a heavy-drinking manic depressive. The crazier he is, the more money you're going to make." (Buffett was referring to his mentor Benjamin Graham's allegory of Mr. Market, a character offering to buy from or sell to investors at a different price each day.) (1997) 

7. "We regard volatility as a measure of risk to be nuts." (Buffett said short-term price movements are meaningless and pose no threat to a long-term investor, whereas active trading, paying excessive fees, and borrowing money are real ways to damage future returns). (2001)

8. "The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability of that investment causing its owner a loss of purchasing power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period." (2011)

Another pundit, Fundstrat’s Tom Lee believes most of the bad news is already priced into the market. 

Stock market outlook: Violent February rally could lead to record highs

US stocks are due for a "violent" rally in February that could lead to new record highs by the middle of the year, according to Fundstrat.

"When markets are this fragile and nervous, the probability for positive surprise is higher," Lee said.

The stock market is set for a "violent" rally in February after a series of mega-cap tech earnings rocked investor confidence this week, according to a Friday note from Fundstrat's Tom Lee.

Lee's expectation that the stock market will surge to new record highs by the middle of the year stems from the fact that, according to Lee, a lot of bad news is already priced into the market.

"Facebook decline does not negate violent February base case [for rally]," Lee said. Specifically, Lee observed that retail investors put $53 billion into money market funds over the past two months, retail investor sentiment has dropped to its worst reading in eight years, and markets sold everything on Thursday after Facebook's weak print.

"To me, when markets are this fragile and nervous, the probability for positive surprise is higher," Lee said.

Of the 53% of S&P 500 companies that have reported earnings so far, 80% are beating income estimates by a median of 6%, while 75% are beating revenue estimates by a median of 4%. Those results suggest "operating leverage [is] still in place," Lee said. Meanwhile, daily cases of COVID-19 have plunged 90% from their peak in New York and Connecticut. That should help improve consumer confidence and also help the labor market as more people seek to get back to work, according to Lee.

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I believe that nothing is normal about the current business cycle; it really is unique. It started with a massive COVID-related lockdown, which caused the deepest and fastest recession on record. Then we had a recovery based on re-opening plus an unprecedented peacetime expansion in government spending. But rarely have we seen an economic report as misinterpreted as Friday's jobs report.

The key headline that investors and analysts rejoiced about was the 467,000 increase in nonfarm payrolls, not only well above the consensus expected 125,000 but also well above the highest forecast from any economic group. And if that were the only piece of information in the entire report, it would make sense to celebrate.

But there are plenty of other key pieces of data in every jobs report. One of them is the number of hours worked and that part of the report was not strong at all. Average weekly hours per worker declined to 34.5 in January from 34.7 in December. As a result, the total number of hours worked fell 0.3%, the largest decline in almost a year. 

If that 0.3% drop had come in the form of fewer jobs while the number of hours per worker didn't change at all, private payrolls would have declined about 350,000 in January. Obviously, in that scenario, many of the investors and analysts who cheered Friday's report would have been jeering, instead. And, yet, both situations have the same exact demand for total hours from workers by businesses across the US.

But what about the huge 709,000 upward revisions in payrolls in November and December? Usually, we're big fans of including revisions for prior months when assessing a payroll report. However, the January report every year is different. It's the one time a year when those revisions should be ignored. Why? Because it's the month when the Labor Department goes back and revises monthly seasonal adjustment factors for the whole calendar year. This year, November and December figures were revised up substantially, but all those gains came out of June and July, which were revised down.

But how about those stellar numbers from the other part of the employment report? Civilian employment, an alternative measure of jobs that includes small-business start-ups, rose almost 1.2 million in January, appearing to confirm the strength of the headline growth in payrolls. Meanwhile, it looked like the labor force (the number of people working or looking for work) grew almost 1.4 million. 

However, once again, a statistical quirk was at work. Every January, the Labor Department inserts into the jobs report new Census Bureau estimates on the total size of the US population, which, in turn, affects the numbers on the labor force and employment. That population adjustment was responsible for all the increase in civilian employment and the labor force in January; without that quirk, Labor would have reported a 272,000 drop in civilian employment and a 137,000 decline in the labor force. 

But what about the increase in wages? Average hourly earnings grew 0.7% in January. That's certainly a rapid pace and very likely outpaced inflation in January. But these wages are up only 5.7% in the past year, which is almost certainly slower than inflation over the same twelve months and which is no reason to celebrate.

I am not asserting the January jobs report was "bad" news, that the US is teetering on the edge of a recession, or that the Federal Reserve should call off its intention to raise short-term rates, stop Quantitative Easing, or start Quantitative Tightening. 

Far from it. I expect continued job growth in the months ahead and a rebound in hours worked. The Fed was behind the inflation curve before Friday's report and still is today. We still expect rate hikes starting in March – we think 25 basis points, although the futures market is pricing in a significant shot of 50 – as well as an end to QE in March and a start to QT around mid-year. 

The bottom line on all of this is that the markets are going to slow down to about 10% annual growth from 18%. I expected this last year and have been planning on a slow down for some time. Stocks are still the only way to get a reasonable income and growth and will be for years until bonds move up a lot in yield. Real Estate will have a blow-off spring, but I am very cautious about any significant growth after that. Stay the course and you will be rewarded.