On at least four separate occasions, I have attempted to write thoughts regarding the current market environment. As most of you know, I never write simply to produce content, nor do I enjoy rambling on about basic fundamental or economic data that anyone can digest through the major media or a pundit’s blog. No, my intention, whenever I write, is to record what I am truly thinking; unbiased, unapologetic and candid reviews of the markets and the current environment, and investment moves which I am making for clients and with personal capital. After a few fits and starts, I believe it’s finally time to attempt to articulate my view of our present environment.
Before I delve into these insights, let’s review what we all know, and why most of the generally accepted knowledge is not very helpful and possibly even damaging.
Fundamentals & Geopolitical Nonsense
On a variety of metrics, the market is not a value. One can review a standard P/E chart to recognize the market is now selling at a multiple to earnings that it is historically well above the average. http://www.multpl.com/shiller-pe/ Examining further, one could also point to other, more sophisticated metrics, such as Price to Sales, Price to EBITDA, Price to EV and even Price to Book and decipher a similar valuation argument.
If that isn’t enough, one can deviate from the fundamental norms and point to the narrowness of the market as cause for concern, something I’ve been guilty of on many occasions. Over the last several years, the market has moved from what could be viewed as a balanced, multi-sector basket of companies, representing a broad array of corporate America, to an index heavily concentrated within technology and more reliant on only a few stocks for the majority of its movement. FAANG has not only become a household acronym, but it is something that influences the stock market more than ever before, and it is another potential problem or concern for the markets going forward.
If basic fundamentals are not enough, how about the uncertainty of the geopolitical environment? One would have to be living in a cave not to be aware of the volatility that currently envelops not only the domestic administration but global politics as well.
But, here’s the problem with all of this information. None of this is new; all of this is known, and not a single bit of this has mattered to the markets over the last several years. For a very long time now, the market has been overvalued, politics have been uncertain, and credit markets, tightening due to higher rates, have been predicted. Yet, despite all of this information the markets kept rising. Had investors adopted cautious measures in their portfolios, due to any one of these variables, they more than likely missed out on one of the greatest bull market runs in history.
So why now? Why, after all of these years and with all of this pre-known information, have I become overly cautious to the point of moving a majority of our client assets out of the market? The answer lies in my view of the psyche of the investors, and what I believe to be a psychological capitulation in a manner we’ve never seen in our history before. Let me explain.
Throughout history, bubbles preceding great declines have been classified as periods of great euphoria; wherein, investors discard any thought of risk and scurry into asset classes regardless of the price or rationale. Throughout the last 20 years, we’ve seen two dramatic bubbles, the first being the Internet craze of the late 1990s. During this phase, the investment theme became classified as the greater fool theory; in that, regardless of a company’s fundamentals, the idea was simply to buy something with the hope of selling it to another buyer at a higher price. I don’t know a single person who didn’t realize that this was unsustainable and wouldn’t last; yet, the game continued as folks wanted to grab the opportunities as long as they could, hoping not to be the last one holding the bag. Eventually, reality set in and the game was over. Stocks came crashing down.
Once the investment public was burned in the stock market, they turned to a more tangible, ‘safe’ asset class with the promise of steady returns over time. I vividly recall hearing the statistics of just how successful Real Estate was over the years; and, if you had simply bought a real estate portfolio, or invested in your own property, you could have easily compounded your money at 7, 8 or even 9% per year for the last 50 years. It made perfect sense; and, since ‘They weren’t making any more’, people rushed out in droves for this ‘rediscovered’ asset class. I’ll spare you the recap of what happened because we know. What I find particularly fascinating about this is that, once again, people I knew, spoke with, and considered to be highly intelligent, were not at all fooled by the thought that this could last forever. They knew that asset prices did not race into the sky, and that someone making $30,000 could not afford a $400,000 house. They were well aware that this was a bubble; yet, they too just wanted to make sure they were not caught holding the bag. As they were more fearful of missing out on the upside than protecting against the downside, they were willing to participate in the bubble. The result of the real estate collapse did not only impact real estate but, once again, the stock market. Another bear market ensued and the decline is now considered academic history – the great financial collapse of 2008.
So what about now? What is it that may be misleading folks? Before I offer my opinion, let me relay what I find to be the common theme from the previous cycles mentioned above. It seems to me that throughout history investors generally move together; and, when they’re finally all crowded into one area, at that juncture, that theme no longer works and declines set in. It’s at this point that investors look elsewhere, and they find something new that may have been working just fine while they were all crowded into another area. Once they wake up to the fact that their investment theme is not working, they jump ship and head to the new investment theme and the cycle repeats.
Over the last few years one investment theme has become repopularized as the best, most efficient, safe and consistent way to invest. It has been championed by the most notable investors of our time, Warren Buffett, Charlie Munger, and of course, the Vanguard titan, John Bogle. The idea is so widely accepted that to suggest otherwise would be blasphemy and, by all regulatory measures, considered imprudent. The idea is simply this; over the last several decades, while various investment themes such as technology, real estate, crypto currencies have come and gone, a tried and true method of investing has stood firm and beat them all. Behold, the low-cost, passive, index fund. The concept is simple; and, in hindsight, has proven to yield exceptional results. Over the years, the general market, as measured by the S&P 500, has returned on average close to 10%. Rather than trying to tiptoe through various asset classes, or heaven forbid ‘time the market’, investors would be better off to simply own the entire market, hold on and ride the ups and downs, knowing that eventually all will be fine and returns will be plentiful.
The above theme has become so ubiquitous that over the last few years we’ve seen the greatest move into passive index funds, beyond anything we’ve seen ever before. From my vantage point, the investment community has basically thrown up its hands and simply said ‘Well, if we can’t beat ‘em, we better join ‘em.’ But here’s the rub, while they believe this is prudent, non-risky and truly diversified, a deeper look tells us it’s nothing of the sort; and, in my opinion, it is one of the greatest, unsuspecting bubbles we’ve seen in the last several decades. To say I am concerned about what will result from this seismic move to passivity is an understatement.
The irony of this opinion is that most of the investment community, while attempting to mitigate risk, secure consistent returns, lower investment cost and pursue a ‘tried and true’ strategy, has actually run headlong into yet another overcrowded bubble which will, in my opinion, eventually deflate investor confidence and result in market losses and portfolio declines.
The only insight I have to add to the commonly accepted fundamental and economic state of the market is that, coupled with what I believe to be heightened investor complacency and a widely accepted passive index strategy, the potential for returns has been increasingly diminished and it is more important than ever to adopt patience and to preserve capital.
Eventually Opportunity will Result
While it is my view that asset prices will continue to decline and investors will once again be led astray by the latest, widely accepted investment theme; eventually, great American companies and opportunities will make themselves known. While I have no idea when this will transpire, I do know that only the investors who have protected themselves financially, and most importantly psychologically, will be able to take part.
At this moment our investment strategy, within Joule Financial, is really quite simple. For our aggressive allocation, that which can be exposed to 100% equities, we presently have a nearly 60% cash position. For our moderate allocation, we have our 30% fixed income exposure, combined with an additional 42% in cash, thus resulting in over 70% cash and fixed income. Our balanced accounts consist of 50% fixed income exposure along with an additional 30% in cash for a cumulative total of 80% cash and fixed income.
We view these allocations as being highly cautious and extremely conservative. Furthermore, we have no desire to go shopping any time soon. The only thing we’re doing with cash is considering Treasury Bonds, as a holding place, while we wait patiently for asset prices to become more attractive. We will definitely not let our cash burn a hole in our pocket, nor will we get caught up in the euphoria if the market has more life left to the upside.
We have several thousand email readers, and I’m flattered to hear how widely these communications are circulated. For those who are not clients, my suggestion, at this stage, is to thoughtfully assess your own view of the current environment and investment strategy. Have you given up and accepted the index theme? Have you become numb to the idea of declines, accepting the idea that over time it will always come back? Have you been encouraged to believe that regardless of what you do, if you simply adopt a passive strategy all will be well?
Over the holidays, casually discuss this with family and friends. What is the common theme you hear? My guess is that you will not hear euphoria, you may hear concern; but, I also believe that regardless of the various emotional states, the investment portfolios are all the same, indexed and in the market.
The greatest irony is that, despite all of our political differences, fundamental concerns and general economic worries, the majority of investors have once again ended up in the same boat.