Image Credit: Aleph Blog || Recently I was talking with a younger pastor friend of mind who is pretty bright. I have known him since he was a teenager. He said to me, “I have concluded the the stimulus actions of the Fed and the Government benefit the rich predominantly.” I told him that he was certainly correct.
Sorry for being late with this update. Have you ever considered the idea that trying to avoid depressions encourages cronyism — the government favors the rich through QE and deficit spending? QE inflates assets and commodity prices. The rich benefit from the first, and the poor are hurt by the second. The same applies to most government spending programs. The rich employ accountants and lawyers, and find ways to benefit from changes in the law, and lobby for exceptions to policies that seem to favor “soak the rich.”
The main thing supporting the market as a whole is low interest rates. And as the Fed suggested they are thinking of tightening policy two years from now, short rates rose and long rates fell. Markets anticipate. I can tell you that if the yield curve gets very flat, the Fed won’t do much tightening, unless they are nuts, which is occasionally true.
On March 31st, the S&P 500 was priced to return 0.07%/year over the next 10 years. Today, that figure is -0.67%. At the close on Monday, that figure was -1.03%. These figures do not take account of inflation, so it indicates real annual returns between negative 2 and negative 3 percent.
The only period that compares with this is the dot-com bubble. If we want to hit new valuation records, 4450 on the S&P would exceed the valuations of the dot-com bubble. Thus when I hear investment banks call for 4800 on the S&P 500 in 2022, I think they are just doing what profits them. They push people to take on more risk, particularly near market tops. If ordinary people get more aggressive here, some of the investment banks will take the opposite side of the trade, so they can profit as the market falls. Those at r/wallstreetbets are being the dumb money that the investment banks will eventually profit from.
Investment banks make a lot of money from offering the shares of speculative firms during a bull market. Then they run for cover faster than retail clients can during the transition to a bear market.
In he past, valuation levels like the present have always led to losses 10 years out. Unless your portfolio is vastly different from the market as a whole, you will suffer these losses. Only if you buy the stocks that have not done well over the past 5 years do you have a chance of producing positive returns. It is exactly parallel to the dot-com bubble. You must avoid large cap growth.
At some point in time the S&P 500 will have a value under 3000. The more interesting question is whether it will have a value under 2000. I don’t think it will ever reach three digits again, unless we get significant deflation.
This is an ugly situation. Pare back risk positions. Focus on undervalued companies in industries that will not go out of fashion. Add investment grade bonds to your portfolio to lose less in real terms than you will get from investing in the S&P 500 index.
Just as no one thought they would lose in late 1999, so it is now. Be aware, and reduce exposure to large cap growth stocks. Replace them with value stocks or investment grade bonds.
Hi David,
Thanks for sharing your estimates and work on the average investor equity allocation. I recently wrote an email to you asking if you have done similar studies for other countries. I read that while the US has 45% the UK is at 10% average equity allocation. Have you seen if the average equity allocation can be applicable model for other countries or you reckon everything moves together with the S&P? The Hang Seng for example gained after the dot com bubble and was not flat to down in 10 years. Peak was 7 years later… this could be an opportunity to outperform if you are selective because while you are saying avoid large cap growth names it is worth noting that the US has outperformed the world last 10 years since Osama died and the USD has been the strongest currency. It may be the case of avoid US stocks here and be aggressive in Australia which has value oriented index and has been flat since GFC.
Looking forward to your timely response.
David,
Is this CAPE forward returns, or the money-flow based model?
Also, how do you think about the fact that CAPE Excess spread is still positive?
Thanks.
As usual, great stuff.
The bailouts always favor the rich. As I am sure you know, people like Charlie Munger have basically said that the peasants should shut up and be grateful because if the rich hadn’t been bailed out (bailouts are ongoing), the peasants would have had an even worse outcome.
Sheila Bair had a plan to go into these financial firms and do a few things: 1. protect depositors 2. fire management 3. re-open by selling to a healthy firm. She was laughed out of the room, and resigned (around 2008).
Never forget that all the rich folks you see on CNBC, even Warren Buffet, were bailed out. I wasn’t. Luckily I had taken action to retain most of my gains, so I did pretty well. These people that are supposed to be so much smarter than the rest of us? Probably not so much. They are just in the right club.
You’ve persuaded me. How do I persuade my young?
Given the extreme valuations of the market and exuberant behavior by average investors, I wonder if even deep value stocks and funds will provide a reasonable return going forward. What worked back in 2000 – 2010 may not work this time around. I currently like Aegis Value (AVALX) which is heavily invested in resource stocks including precious metal miners. Manager is a deep value investor with portfolio currently having a P/B of 0.8 and average stock market cap < $800M. This fund outperformed during the 2000 to 2010 bear market but does lag during times when growth stocks are in vogue.Currently looking for other deep value funds to protect capital over the next 10 years. Just wish T. Rowe Price Capital Appreciation was still open. I’m thinking maybe a good balanced fund from Dodge & Cox or Oakmark might be a worthy holding at this point.
Any thoughts about the attractiveness of local-currency (or hard) emerging sovereign bonds at this point in time?
IMO valuations will go higher than the last tech bubble. Trend over time has been bubbles getting bigger and valuations getting higher. Accommodative FED, low interest rates will support the market and technology which is truly changing the world will cause euphoria in investors and the market. We have a ways to go before the top is in, IMO.
I work in the tech industry (software for years, now in IT), and I see the world moving to the cloud in droves. I see the SAAS companies growing 30-100%+ per year in revenue. Yes they are 20-50x sales valuations, but when you are growing that fast and your growth is accelerating every quarter, and it’s obvious the entire world is going to be using your product in the near future, what is the proper value? All I can do is buy on pullbacks, and wait for euphoria signals like the 90s (CNBC on the tv at the country club instead of ESPN, stuff like that). When I start seeing that stuff, I’ll sell some on pops, and then trail the rest with a moving average to get me out after the bubble pops.
David I believe you are a very smart guy, and a very good investor. As with most good value investors, they are early. Just my opinion.
Dumb question but when you say the expected returns are under 1% are you simply just doing an inverse of the current S&P PE ratio, which is around 44?
To those asking how David calculates this, the model is here:
https://alephblog.com/2016/04/16/estimating-future-stock-returns-follow-up/