Graphic Credit: Aleph Blog, natch… same for the rest of the graphs here. Data is from the Federal Reserve and Jeremy Siegel

As I said last time, a lot can happen in 3 months. At the end of March 2020, a rally was starting that would become a new bull market. At that time, the market was poised to deliver a return over the next 10 years of 6.84%/year. As I write this evening, after the rally the likely return over the next ten years is 4.63%/year.

Hee are a few more graphs, and then I will come to my main point for this post.

25 scenarios — one down, 24 up over ten years, with an average likely return of 4.63$/year.

In general, this model fits the data well, but who can tell for the future? This is likely the best estimate over a ten-year horizon.

So, do you go for stocks here with a likely return of 4.63%/year, versus the Barclays’ Aggregate at around 2.5%/year or cash at around 0.2%/year? You can hear the siren call of TINA (There Is No Alternative) loud and clear.

Let me peel this back a bit for a moment, as one who once managed a large portfolio of bonds. Why not always buy the highest yielding bonds? The answer that would come back from the bright students would be: don’t the highest yielding bonds default more?

The bond manager that buys without question the higher yielding names presumes stability in the financial markets, and likely the economy as well. Defaults can affect the realized yield a lot. You might be getting more yield today, but will you be able to realize those yields? In addition to losses from defaults, many managers lose value during times of credit stress because they are forced to sell marginal bonds that they are no longer sure will survive at distressed prices.

I think the estimate of returns that I have given on the S&P 500 is a reasonable estimate — it’s not a yield, but an estimate of dividend yield and capital gains. 4.63%/year over 10 year certainly beats bond handily. But do you have the fortitude, balance sheet, and time horizon to realize it?

More say they have it than actually do have it. The account application form at my firm stresses the risks of investing, and talks about stock investors needing a long time horizon. I still get people who panic. The present situation, given the novelty of a virus “crowning” (idiom for a whack to the head) the market, and the market largely ignores it makes many panic, assuming that there must be a big fall coming soon.

Eh? There might be such a fall. The S&P 500 could reach a new high in July. Who cares — that is why I run a 10-year model — to take the emotion out of this. If you are afraid of the market now, you should do one of three things:

1. Sell your stock now — you are not fit for stock investing.
2. Sell your stock now, and choose two points where you will reinvest. What is the lower S&P 500 that would give you comfort to invest? Second, if after an amount of time the market doesn’t fall to the level that you dream of, at what date would you admit that you were wrong, and reinvest then.
3. Do half — sell half of your risk away, moving it to safety. Again, try to set a rule for when you would reinvest.

In general, I don’t believe that there is no alternative to stocks, and I don’t think stocks are cheap, but in general, the optimists triumph in investing. I have been shaving down risk positions, but with the Fed doing nutty things like QE infinity (whatever it takes), buying corporate bonds and doing direct lending, I don’t see how the markets fall hard now. The dollar may be worth less when it is done, but I think it is likely that you will have more ten years from now by investing in stocks and risky assets like stocks, than to invest in safe assets.

When the Fed shifts, things will be different. As Chuck Prince, infamous former CEO of Citigroup once said:

“When the music stops, in terms of liquidity, things will be complicated,” Prince said. “But as long as the music is playing, you’ve got to get up and dance.”

What we have learned 10 years after Chuck Prince told Wall St to keep dancing

As I wrote in my Easy In, Hard Out pieces, the Fed will have a hard time removing stimulus. They tried and the market slapped them. Now they live in a “Brave New World” where they wonder what will ever force them to change from a position from a position of ever increasing liquidity. They try to not let it leak into the real economy, so there is little inflation for now.

But there is no free lunch. Something will come to discipline the Fed, whether it is inflation, a currency crisis — who knows? At that point, “things will be complicated.”

So what do I do? I own assets that will survive bad scenarios, I raise a little cash, but I am largely invested in stocks. To me, that is something that balances offense and defense, and doesn’t just focus on one scenario, whether it is a disaster, or the Goldilocks scenario of TINA.

Photo Credit: frankieleon || Even with low inflation, money shrinks. Wages move with inflation, few assets do.

There’s no free lunch. The ideal of an inflation-protected defined benefit plan was indeed wonderful, but the costs were prohibitive. Few companies were willing to shoulder the costs of them, and what few were willing ran into the roadblock of the IRS telling them they could not put too much into their defined benefit plans — for the IRS feared it was a tax dodge.

By nature the IRS is shortsighted, and could not appreciate the idea that you needed more assets than the liberal (meaning you don’t need to contribute much today) funding formulas said they would need. The IRS wants taxes now. They don’t care about taxes five years from now, much less thirty.

As it is today, most of us (including me), are stuck in the box where we have to make our assets last over our retirements. There are no guarantees. How do we make the assets stretch?

It’s a tough problem. I often talk to my friends about the challenge, because we really don’t know whether the idiotic policies of our government will lead to inflation or deflation as a result of the crisis. Most people assume the government will inflate, and that seems to be an easy solution.

But they didn’t do that to any great extent in the Great Depression or in the 2008-9 financial panic. I’ve got bad news for most people: the government of the US, nay, most governments tend to favor the rich. As such, they tend not to inflate aggressively.

But as with most matters in economics, past is not prologue. Who can tell what the government might do in an entitlements crisis mixed with a weak dollar? What happens when so much credit is extended that foreign creditors distrust the value of the dollar (or euro)?

But suppose inflation is your worry. How can you hedge?

First there is storage: t-bills and gold. You won’t earn anything, but you won’t lose anything either.

Wait, why not buy gold miners? I class gold miners in the basket of industries that I call “cult industries.” Cult industries attract businessmen and investors that are “true believers,” who have a view of the world that says the activity is more valuable or cool than most other industries.

The problem with gold miners is depletion. Has the price of gold risen? Yes, but so has the cost of mining gold. There are many people who have bitten the romantic lure to mine gold, and as such, typically gross margins are poor. Buying gold miners has been a bad bet for a long time. So just buy a little gold instead, and not the miners.

Short duration bonds can be useful if their yields are higher than expected inflation plus default losses. Otherwise, bonds are usually not a good hedge for inflation.

With stocks, for the market as a whole, rising inflation is a small net negative. Businesses will raise their prices, but a higher cost of capital overall will make stocks lose ground to inflation in real terms.

But if you tweak your stock portfolio, and pursue either a low P/E approach, or one that favors a overweight of cyclicals, you can use those stocks as a hedge against inflation. Just be aware that when the cycle shifts to deflation, those stocks will underperform.

Real estate typically does well in times of inflation, just make sure any loans you have against the real estate won’t reprice upward to reflect the new higher interest rates.

That’s my quick summary for asset classes. Before I close, I have a few words regarding the unique ways that inflation affects seniors:

First, inflation affects you more because you don’t have wage income coming in. Wages mostly adjust to inflation — if you have work, that is a source of support.

Second, things that are necessary — food, energy and healthcare, have tended to inflate at a rate faster than other goods and services. That might not be true of energy now, but it was true for a long time.

My main bit of advice is to be conservative in your spending. That’s the one thing you can control. Making assets last for a long time, is difficult, but it becomes impossible when your asset levels get too low.

With that, invest wisely. Personally, I would pursue a middle course that partially hedges inflation risk, because the cost of being wrong on either side is significant.