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It happened. The Fed openly admitted that their rate hike policy was going to slow down the economy and tighten the jobs market. Of course, every economist paying attention already knew this, but the open admission from Fed Chair Powell is a point in the right direction. That being said, the Fed still has a very difficult job ahead of them in trying to calm the inflation storm, while still having strong employment.
Last month, the June inflation rates came in at 9.1%, a clear rise from the inflation rate of months prior. While many may see this inflation rise as a failure of the Fed’s previous interest rate hikes, the reality is that, from the Fed’s point of view, all previous hikes have gotten us to a neutral position and any future hikes will quell the inflation. The next inflation announcement is scheduled for August 10th, and we will be watching very closely.
Regardless of the Fed’s actions, it is safe to say that we are in for a bumpy road over the next several months, or even years. Economic contractions are certainly not ideal for investing, but we believe that there are plenty of opportunities for capital returns to be achieved during these times. In a stagflationary environment, cash flows are king. To put it simply, it is time to invest, not time to speculate.
In the last newsletter, I hinted that “investing” in equities on the stock market isn’t investing at all because these assets generate no cash flows. I stand by that comment. My investment thesis is very simple: I am an investor. When I send my dollars out into the world, they make the world a better place and that added value is reflected back to me in the form of cash flows.
Put simply, there are only two ways to achieve capital returns through an investment: cash flows, and price appreciation. Most investments do both, but for a pure cash flowing asset, think of a machine in a factory. Every widget that gets made is thanks, in part, to the machine and the machine is not sold at the end of its life. For an asset on the other end of the spectrum, think of Bitcoin. Bitcoin does not even have the possibility of producing cash flows, and the only way to achieve a return is to sell the asset at a premium. It is true that many speculators have become wealthy by selling assets for more than they bought them for, and this certainly works in long bull markets, but we are entering a new stage of the cycle where this is not realistic.
So what are the differences between speculations and investments? Benjamin Graham took a shot at it in The Intelligent Investor when he claimed that the difference was a matter of risk. Investments, according to Graham, are cautious and conservative while speculations are aggressive and enjoy a more daring risk profile. Unfortunately, this is about as specific as Graham was in his book, so I would like to add a bit more specificity:
- Does the investment have a history of producing cash flows?
- Am I relying on asset price changes in order for capital to be returned?
- Is my injection of capital likely to change those cash flows?
As you can tell by the criteria, cash flows are king because the alternative to cash flows is hope, and hope is not a strategy. Cash flows are important for another reason though, they are an indication of value. The mechanics of cash flows are simple, customers pay for goods and services and the profits of their purchases are returned to the investor. When an asset is cash flowing, we can safely say that the asset is adding value to the lives of the people paying for your goods and services, or else they would not be your customers.
The third indicator is an important one because it encourages investors to contemplate the mechanics of their investment. For example, buying a share of a dividend stock like Microsoft will produce cash flows, and it is possible that capital could be returned with no exit on the stock at all. The problem arises when you peel back the curtain to find that the stock was purchased by a broker, from a broker, and the investment you made cannot be used by the company in any meaningful way. Your purchase of a stock will have no effect on the future cash flows.
Harsh as it may be, this disciplined approach to investing is critical for this time in the economic cycle. The Fed will continue to increase rates which will cause many to lose their jobs and even more to suffer losses through their investment positions. As always, all roads lead back to real estate and its value generating cash flows. We at Peak 15 believe that we are in the right place at the right time to take advantage of opportunities as we see them. We are investors, adding value to the world through strategic capital allocation. And that value is returned to us through cash flows.
Keep climbing!
