You may be wondering about the odd title and what it can possibly do with investing. Coming up with fresh ideas on what to share in our QV Update can get more challenging as the year goes on. So today we thought we’d discuss fruit. The common banana – one of my favourites as it’s both filling and cheap… or so I thought. You may have heard that a couple of weeks ago, Sotheby’s Auction House listed Maurizio Cattelan’s duct-taped banana, named “Comedian”, for between $1 million and $1.5 million. The piece ended up selling for over $6 million! The background story is the single banana was reportedly purchased on the day of the auction for $0.35 and duct-taped to a blank wall… talk about return on investment!
The idiom “go bananas” means to become super excited, emotional, or even irrational about something. We won’t judge the buyer’s state as we know art is a personal matter… obviously beauty is in the eye of the beholder!
We’re seeing this super excited emotion expressed elsewhere, and much like the banana, are missing out on some of the returns. Year-to-date, 2024 has been a good year for investors and, in certain sectors and markets, a great year. While we are pleased with how our portfolios have performed for the most part, it’s been a challenging year to compete with the returns produced by many super-charged benchmark indices. The pattern of our historical returns over more than 25 years clearly shows this predisposition to lag in exactly such periods. We illustrate this with the returns in our long-standing Canadian small cap portfolio. The blue circles note high-returning benchmark years where we lagged. More importantly, the orange circles are the years where we significantly protected our clients’ capital while the market declined.
Source: QV Investors
In the Canadian markets we have held in reasonably well to the benchmark returns. Global mandates have been more challenged. There’s a simple reason for this – U.S. markets have gone bananas! Ok, maybe that’s a bit dramatic, but near 30% index returns on the back of one of the most highly concentrated and highly valued stock markets in history suggests a degree of emotion at the very least. The chart below illustrates that U.S. stocks have outperformed relative to equities in the rest of the world to the most extreme degree in at least 75 years!
Source: Bank of America Global Investment Strategy
To be fair, just because one market has performed better does not mean it’s not fundamentally justified; it may very well be. But when markets get this stretched in both relative performance and valuation (we will spare you a valuation chart in this letter) the likelihood of a reversion to the mean increases precipitously (in plain English, this means things reverse and go back towards the averages).
There is one caveat to our commentary above, which is that we never know how long the good times will last in the winning markets. They usually last longer than we think they will; we see no reason this won’t happen again this time. Take, for example, in 1996 when Fed Chairman Alan Greenspan made his famous speech suggesting “irrational exuberance” had begun to play a role in the stock market’s surge. He was right, but it took nearly four years for the market to finally peak in early 2000. This was the infamous “tech bubble” which had a parabolic rise and an equally devastating collapse, wiping out many individuals’ savings along the way. As an aside, Chairman Greenspan’s words “irrational exuberance” are the formal version of “going bananas”.
Capital Flows – Momentum driving the market
Momentum is the speed at which an asset price changes. New investment capital is typically allocated to markets and companies with the highest recent returns. We are witnessing high returns beget higher returns (momentum) as new capital continues to push prices up. The corollary is that the weakest-performing assets not only lag, but investors redeem their holdings to provide capital for the current best-performing assets. This further exacerbates the extremes. The premise that something will continue to go up because it has gone up becomes widespread, as does the confidence of the buyers.
Irrational exuberance – or maybe it is rational and we are just wrong (wouldn’t be the first time) – is evident in the chart below, which shows Americans’ expectations for higher stock prices at a near 40-year peak!
Source: InvesTech Research, November 2024
We’ve lived through these times in our investment history. While it can be challenging in the near term to keep up with the markets, the discipline to invest where we deem both the future returns to be attractive and the risks manageable has been rewarding. The timing of shifts in markets is impossible to forecast. But we remain certain that the best return opportunities always appear when investor sentiment is gloomy and stock valuations are cheap – the opposite of what the U.S. market looks like today.
This is our final letter of the year. We wish all of you peace and health this holiday season. We also wish for you to start the bidding on our QV Christmas Tree which has been adorned by a $0.35 banana …. does this make it worth $6.2 million?
