🔔 'David, what's your favourite stock over the next five years?'

OK, so last week we received a handful of questions from you.

There were a tonne to pick from, but I particularly liked this question

Hi David, (thx for the info) - what’s your single favourite stock for the next five years?

This is a good question.

But rather than answer what I think my favourite stock will be right away, I want to guide you through why I might pick this particular stock, because it'll help you understand the themes that I think are at play.

First and foremost, my view on yields and inflation is completely unwavering:

We have at play, 40 years of structural factors leading to lower inflation and bond yields (you will see why I am interchanging these at the end).

With these lower bond yields, through liquidity provision from the Fed over the various crises we have experienced over the past decade and a half, and now 'fiscal liquidity provision' as I like to call it, I'd argue our central banks have their backs up against a wall with regards to monetary policy.

Said policies have led to equity indices have the greatest concentration towards the top 5 stocks in history - and they're naturally all tech firms. See the following charts from Schroder's.

I'd like to introduce a concept known as 'equity risk premium compression'.

Really, it's just a simple calculation.

It's the return above and beyond a risk free rate, which is generally the US 10 year yield.

It is rather theoretical, but it can explain why tech socks LOVE when bond yields are lower.

See, growth stocks (tech) are consistently based on future cash flows.

If you have a lower bond yield (risk free rate), then future cash flows are discounted far less.

With a higher bond yield, they're discounted more.

See below as an example.

You've got Amazon in white and the US 10 year yield in orange.

Note how Amazon ranged when yields started to rally and more recently, started to push higher as the 10 year yield cooled off.

Now, why did yields cool off?

This is where we talk about inflation.

Below is the US 10 year breakeven inflation rate.

This gives us a market based expectation of inflation over the next 10 years by measuring the difference or gap between 10 year Treasury Bond and Treasury Inflation Protected Securities (TIPS).

Bond yields are generally used as an inflation gauge.

If inflation gets priced in, you generally will demand a higher nominal yield, otherwise your return gets eroded away.

If yields head the other way, you can generally expect inflation expectations to dampen.

At the start of this year, we saw yields head up pretty ferociously, but my view was that this would be temporary due to my backing of the Fed with their 'inflation is transient' talk.

We are indeed now seeing yields cool off.

I wrote about this below.

Here's the 10 year yield chart from the above piece updated.

If we were set to see massive inflation, we would see yields higher.

But we aren't, we are seeing them soften.

So what does this mean from an investing perspective?

If we are to continue along the rate path that we have experienced for the last 40 years, then the place to be putting your capital is into growth stocks such as Apple, Microsoft, Facebook and Alphabet.

But I favour either Apple or Microsoft, personally.

I believe them to be pretty anti-fragile (I like the word, even if Nassim Taleb has blocked me).

Google for me, has the largest risk associated with it when it comes to potential breakups of Big Tech.

And Facebook, I just don't like - even if I am an avid WhatsApp user.

But the crux of the matter is that tech stocks like lower yields, and the current and forward looking environment is in favour of staying long them, and it'd probably be advisable to have exposure to the broader indices too (SP500, NASDAQ), obviously.