The Boredom Markets Hypothesis
Incomparable Bloomberg columnist Matt Levine has a theory called the “Boredom Markets Hypothesis.” It says people will buy stocks when buying stocks is more fun than other fun things.
That, Levine says, accounts for the huge burst of retail trading during the height of the COVID-19 lockdowns, when there was little else to do.
At the Bauman Letter, we buy stocks to make money. We’d like it to be fun, but that’s not our priority. This is not a Reddit chatroom, after all.
But Levine’s idea got me thinking about when and how we make money from stocks … and about how that changes with the circumstances.
During peak lockdown, everybody was oriented toward the future.
In the stock market, that translated into huge flows of money into companies that will only turn a profit years from now, if ever. After all, if the pandemic meant that most companies weren’t making money in the here and now, why not bet on future profits?
The problem is that the present value of future profits is always changing.
One way is through inflation, which reduces the present value of future money. Clint Lee and I have talked about this several times in Bauman Daily.
But there’s another variable with an even bigger impact on the value of future profits: risk.
And my risk antennae are telling me that risk is growing … and that smart investors need to shift their strategies with it.
A Tale of 2 Tickers
While there’s probably some truth to the Boredom Markets Hypothesis, most people buy stocks for income. That can come from one of two things:
- Price appreciation: If you bought special-purpose acquisition company Churchill Capital Corp. IV (NYSE: CCIV) in January this year, and sold sometime in the third week of February, you would’ve made a return of around 500%. During that time, its market capitalization soared to over $15 billion.
- Regular cash payouts: If you bought the Invesco KBW High Dividend Yield Financial ETF (Nasdaq: KBWD) about this time last year, you’d be earning an annual dividend yield over 10%.
But that was then. This is now.
After reaching a high price of $58.05 on February 18, CCIV stock lost half its value over the next two weeks. It eventually bottomed at $17.75. Everybody who bought CCIV during the third week of February got wiped out.
Meanwhile, KBWD kept churning out fat dividend payments every month.
The difference in the respective fortunes of the two tickers comes down to risk.
Churchill Capital planned to merge with electric vehicle (EV) designer Lucid Motors, considered one of the top potential competitors to Tesla.
Everybody wanted a piece of that action!
But when the merger consummated, it was clear the company’s management didn’t believe in that $15 billion valuation. And once investors started to realize that most EV startups would never survive to profitability, they decided the risk didn’t justify holding the stock. They dumped it en masse.
Meanwhile, a $100,000 investment in KBWD would be paying out over $830 a month.
Bidding on Future Money vs. Present Money
During the stimulus-fueled mania for “growth” stocks such as CCIV that collapsed in March this year, people were willing to bet their money on the prospect of future profits from companies that don’t even have products yet.
They placed a high value on future money.
But once the market realized that economic life after lockdown would be full of uncertainties — inflation … interest rate hikes … higher taxes … congressional gridlock — it decided there was a big risk that future money might never materialize.
So, it bid down the prices of that future money, in the form of stock prices of companies such as Churchill Capital.
But investors had to do something with that money.
The Boredom Market Hypothesis crowd flocked to things such as crypto and meme stocks. They got crushed again.
But the smart money did something very different.
It chose to invest in present money — companies producing cash income and dividend payments right now.
For example, here’s a chart of a real estate investment trust (REIT) that pays an annual dividend about twice the current yield of a 10-year Treasury bond:
This boring company, operating in an unremarkable real-world market segment, is beating the pants off the S&P 500 and the Nasdaq year to date.
That’s happening because smart investors realize that, although risk has diminished the value of future money, it hasn’t done anything to present money.
A dollar in dividend income received this month is worth a full dollar’s worth of goods … at minimal risk.
By contrast, nobody knows what the profits of speculative growth stocks will be worth someday … if anything.
Risk off = Profits On
Low-risk companies that earn strong current cash flows and pay decent dividends are being rewarded by the market.
That’s precisely why my current strategy for The Bauman Letter is to add such companies. Last month, we acquired a REIT yielding almost 7.5% that pays monthly dividends. And there’s another one coming up next week.
So, if the Boredom Market Hypothesis isn’t your cup of tea, keep reading The Bauman Letter.