The Cost of Omission
Part 1
Valuations are mostly deserved – among one of the better things I've read all week has been the idea that most (recent) bubbles have been driven by active management, not passive.
I don't think we are anywhere near a bubble; the diluted PE across the Mag-7 is still a good 20% below what it was at the 2022 peak. The Mag-7 companies have become more cashflow focused, they continue to grow strongly, they are showing excellent operating leverage and all the capex is flowing through to one name, Nvidia. The Mag-7 have done well not because of speculation, but simply in response to good earnings and good management.
I worry constantly about the cost of omission (which really is just FOMO). Especially when 7 companies can move the needle so much.
One more data point (shamelessly stolen from Lazard).
- EPS for the Magnificent-7 has grown +30% from the March-22 peak while the average PE ratio has contracted -6 points.
- The remaining 493 stocks in the S&P500 have only grown EPS by +4.8% over the same period while the PE ratio has contracted -1 point.
Why on earth would you not want to hold 7 companies that represent strong EPS growth?
Part 2
I posed a question of a similar nature about omitting investments to a number of people in our industry last week – why not hold bitcoin if the cost of omission is so high?
I acknowledge there are issues with custody, insurance, risk management, and institutional ownership. But if you wait until all these issues are resolved (and I take the view these will be resolved over time), then you would have missed out on the opportunity as good news is priced in completely.
Climbing the wall of worry can sometimes lead to good risk adjusted returns and achieving a Cash + 5% target doesn't sound like an onerous ask here. Risk is measured by volatility, but is that really the right measure if you don't require daily liquidity and are happy to hold until several catalysts occur? You don't even need to make a large allocation. Things go wrong, you lose small. Things go right, you win big because there is some amazing convexity.
Before anyone argues with me about the purpose of Bitcoin, we should look at Gold. As some perspective, I have bought more physical gold than pretty much anyone who reads this. What is the purpose of holding a non-producing asset that is the proverbial shiny pet rock? I don't exactly know but holding a bar of gold is a lovely thing everyone should experience at least once in their life.
Exactly the same purpose exists for holding digital gold. The original NFT.