This morning I read a good article in the WSJ, posted below. The article discussed that, as a whole, stocks and bonds are pricey by historical measures. Highly valued stocks and bonds have very likely pulled future returns forward, meaning many investors have less of an opportunity for big gains in the future.
“U.S. stocks currently trade at almost 30 times the average for inflation-adjusted corporate earnings over the past decade, versus a long-term average of 16.65, according to data from Yale University professor Robert Shiller.”
As many of you know that have been reading my articles, at T&T Capital Management, we are of the belief that many market participants are making a very big mistake, as they shift towards riskier investments. It has become a nearly “consensus” opinion to own index funds, regardless of valuations. This is actually an approach that most advisors seem to be pursuing. Surely they will mix in bonds and international indexes too, but valuation isn’t a prime consideration for them. This would likely be okay if the market were very cheap, but it is likely going to be very costly with where things stand today, with over $13 trillion in debt yielding negative interest rates.
You might ask, why would we want to own bonds at all with 10-year Treasury yielding 1.68%?
The reason most advisors buy them is to control the emotional aspect of investing, as clearly there isn’t much income being obtained by them at these levels. Stock volatility can often cause investors to panic at the exact wrong time. If stocks and bonds are your only tools, this can seem rational. Our different approach is done via increasing our tool set broadly with things like publicly trade REITs, cash-secured put and covered call strategies, and hand-selecting individual stocks and bonds. These tools can offer risk-reduction, enhanced yields, and alternative returns when times get challenging.
For young investors such as millennials, the starting valuations of stocks and bonds pose real problems. From the article, “Consider a 25-year old who earns $100,000, expects to work until age 65 and wants to save enough to maintain his or her standard of living in retirement, together with Social Security.
Assuming this person invests 60% in stocks and 40% in bonds and earns a historical average annual return of 7% after inflation in stocks and 3.5% in bonds, the recommended savings goal is at least 9% of earnings a year, according to Mr. Blanchett. Delaying until age 30 raises the annual savings target to at least 12% and waiting to start until the age 35% increases it to 17% or more.
But if the person encounters subpar investment returns—of 4.5% a year after inflation for stocks and 1% for bonds—in the first two decades of his or her career, the recommended savings goal rises to at least 11% for a 25-year-old, 15% for a 30-year-old, and 21% for 35-year-old.”
For the average investor, taking that traditional 60/40 stocks/bond approach, I find it very difficult to believe that the optimistic scenario would transpire. Returns from bonds generally tend to revolve around the starting yield, and with yields so low, future returns are almost assured to be much lower. This is where our cash-secured put and covered call strategies can really provide a better risk-adjusted option.
It is essential to save money and invest it. The people that are most successful with this generally have it as part of a routine. They contribute to 401k or 403B plans, they ACH money into their cash accounts and fund their IRAs. Money sitting in the bank earning nothing, beyond emergency funds, can be quite a hindrance to long-term retirement goals.
Many people get into a bit of a trap with real estate. They like having the physical asset, but they don’t factor in all of the carrying costs of it, such as property taxes, insurance, maintenance, and of course any financing costs. Real estate appreciation is not guaranteed and it is generally less liquid than stocks and bonds. Transaction fees are massive so that, unless you are an agent, the more transactions you do the less your returns will be. Obviously there are professionals that treat it like a business that do really well, but unless you really want to approach it like that I’d be careful. We have the ability to invest with many of the best real estate minds in the world through their publicly traded securities without half of these headaches.
There is a lot in this article to think about. We have been in a 10.5 year bull market. There are still some good opportunities but there are also many risks. I wouldn’t be shocked if we saw a technical recession within the next 12-18 months, due to some structural issues with Boeing, the GM strike, and trade anxieties. This is likely overdue and isn’t something to be overly stressed about. Whenever we make an investment we do so with the thoughts of how the company will be impacted by a slower economy and/or recession.
Worrying about the next recession and staying on the sidelines is usually much more costly than the actual recession. Over the last few weeks, we’ve been able to lock-in some nice profits and free up cash. We’ve also been investing into cash-rich companies that should be poised to take advantage of future turmoil as it inevitably arises. I feel good with where things stand and I continue to add regularly to my personal accounts, although we are doing some renovations to the house, which are of course costly.
We bought our house about a year ago when I moved my family back to Orange County, CA, which is where I’m from. We plan on being here forever, but at least 20 years as our children grow. Being in a home a long time dramatically decreases those transactions costs from the buying and selling of real estate. I’d encourage younger clients to think that way and not worry too much about renting if it is necessary until they are settled with where they want to work and live for most of their prime life. I share this stuff because I always want to deal honestly with you all, as that is what this firm is based on. We eat our own cooking and if we can help anyone by sharing our thought processes, we feel fantastic.