Economists have observed “wealth effects” that magnify market momentum – a powerful force that pushes stock markets in both directions. Wealth effects are a feedback loop between stock markets and consumer spending, and they work roughly like this:

Mr. Smith’s stocks go up à Mr. Smith feels wealthier à Mr. Smith spends more money à Mr. Smith’s spending lifts corporate profits à higher corporate profits lift stocks further … and repeat.

Considering the many Mrs. & Mr. Smiths in the economy, we can begin to appreciate the scale of this impact. Rick Rieder, BlackRock’s Chief Investment Officer (and a finalist for the Federal Reserve chair), suggests wealth effects are increasingly driving the US economy, led by outsized spending from people over the age of 55. Importantly, this cohort of retirees owns a meaningful portion of liquid assets.

Source: The Economist

With this setup, a fault line may be forming. We believe many of these retirees don’t have proper retirement plans in place, and may become panic sellers in the next meaningful market correction. At a certain level, wealth effects may trigger in reverse, slowing down consumer spending and corporate profits. This is not a macroeconomic prediction. But, we aim to prepare for challenges across market cycles. We should have our umbrellas ready before a storm hits.

To that end, we focus on resilient wealth creation. While we mostly own shares of great businesses, we also hold cash and short-term fixed income to provide a smoother ride. This personalized allocation feels like a drag when stock markets are strong, but it’s well worth it for eventual downturns. Not only does this defensive sleeve tend to hold its value, it also works as an ”opportunity fund”, giving us the option to buy great businesses on sale in a protracted bear market. In tandem with our approach, we believe strong results come by shifting our lens, and zooming out to take a multi-year view.

Consider Galilean relativity – a useful idea from physics. If I’m riding a train with an apple in my hand, it appears to me like the apple isn’t moving. But, to another person watching from outside the train, the same apple is moving quickly, at the speed of the train. The lesson is simple: our perspective changes everything. We should use this idea to improve our experience aboard the “investing train”.

On one hand, we could choose to ride something like Ozzy Osbourne’s Crazy Train: with flashy fads, constant fears, ‘soaring’ one day, and ‘plunging’ the next … or, we can take a step back, and see this train in its proper perspective – as a Gravy Train for long term wealth creation. This train might take a winding path, but it still moves toward a wonderful destination.

Howard Marks, a billionaire investor, drove home this key point on a recent podcast appearance:

“The most important thing for investors is to get on that gravy train and stay on it. Invest, invest early, invest a lot and don’t tamper with it.”

This is timeless advice worth keeping top of mind. As always, please let me know if you have any questions about your portfolio.

Sincerely,

Luke Charbonneau