Two charts which I think are useful in thinking about today’s investment environment.
Based on my experience and a historical review of market returns and investor market psychology, I continue to recommend that investors avoid most fixed income investments and REITs. My opinion develops from an ongoing broad and historical study of markets of which the Ibbotson chart-Chart 1– provides a useful summary. Link: Ibbotson Associates Chart-Bason Asset Mgmt. This chart provides a comparison of total returns of various asset classes as detailed.
Here’s what Charlie Munger had to say at the Daily Journal meeting
Charlie Munger spoke at the Daily Journal Corporation's Annual Meeting of Shareholders today. Although Warren Buffett is the more well-known Berkshire Hathaway chief, Munger has been at his side through much of his investing career. Q4 2020 hedge fund letters, conferences and more Charlie Munger's speech at the Daily Journal meeting was live-streamed on Yahoo Read More
Chart 2 comes from data developed by Robert Schiller and is available at Irrational Exuberance and lets us compare the market performance of the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) vs. Earnings Per Share. I have added trend lines and P/E lines to facilitate this discussion.
I develop my own investment perspective by looking backwards, measuring our historical investment returns vs. business returns and seeing the impact of market psychology on stock prices, how we have responded to various threats of inflation, global conflict, imagined threats, internal and external geopolitical events and other inputs to market pricing to numerous to detail.
Bubble in the stock market
I cannot in this email detail the history of the numerous ‘global catastrophes’ and how fearful society became each time and expressed the belief that ‘life as we knew it…’ was now over. But, we have had numerous periods throughout history of great concern from which we have always righted ourselves and today is no different from what we have experienced in past periods. Today the worry that seems to be gripping most investors is that both the economy and stock markets are in a “Bubble” which has been caused by the Fed’s and other central bank’s actions to keep interest rates unusually low. Not all believe this, but most do. There are some who are calling for even greater Fed stimulation. At the far end of the spectrum, a very few are (like myself) indicting that the Fed’s working to keep long term rates low is the primary risk but that we will normalize over time.
Bubble in bonds market
The history of bond returns-look at Government bonds ProShares UltraShort Lehman 20+ Yr(ETF) (NYSEARCA:TBT) in the Ibbotson chart-when compared to US GDP over the period shows that over the very long term bond returns are roughly equal to US GDP growth(not shown). But, there are shorter periods during which this relationship does not hold. One such period occurred during the 1970’s inflation era when bonds severely underperformed in response. The period from the early 1980s to Present represent a period of catch-up for bond performance as inflation and interest rates fell. Today the 10yr Treasury sits at 2.6% after ~30yrs of out-performance. We are due for bond performance reversal!
If we simply look at the today’s market and GDP and break apart some of the components as I periodically do, one quickly comes to the conclusion that US growth has actually been unusually consistent from 1930s even with multiple recessions, wars and etc. The earnings for the SP500 have tracked 6.1% from 1940-Present a shown in Chart 2. The US Real GDP like wise has been on a consistent path moving from ~3.9% in 1930 to ~3% today. Today’s GDP appears slower only because government spending has been contracting at ~2% rate while the private economy is growing at a real ~3.5% (5.1% inflation adjusted). With today’s inflation rate of 1.6% from the Dallas Fed’s 12mo Trimmed Mean PCE added to the US Real GDP trend of 3% gives us 4.6%. The 10yr Treasury should be at a minimum near 4.6% not the 2.6% present today. One comes to the conclusion that bonds are extremely over-priced historically because investors carry an enormous fear of equities! It is bonds which are in a “BUBBLE” with a capital “B”.
Stocks are by comparison fairly priced using many historical measures based on earnings, cash flows and even by my own measure, the SP500 Intrinsic Value Index.
Unwinding the current “Bond Bubble”
Investment bubbles always unwind! How and when is not predictable but one can make some guesses. Unwinding the current “Bond Bubble” means that capital will leave that arena and move to other areas. This will drive rates higher and hurt the pricing of existing bonds. But, higher rates will stimulate bank lending which in turn stimulates pend-up demand for home buying and commercial construction projects. We should see higher inflation. This does not mean that home prices will necessarily rise. Real estate prices are generally priced on capitalized rental streams. Rising rates can hold housing prices in check even though many more are getting financing . Only time will tell as to how this plays out. One sure benefit will very likely be rising stock and commodity prices as fixed income investors seek higher returns.
The current “Bond Bubble” turning into a “Stock Bubble”
One can foresee the current “Bond Bubble” turning into a “Stock Bubble” as equity market psychology turns more positive. Stock markets can rise to levels which seem insane by historical valuations. We did this in the late 1990s ending in 2000 with a market 100% over priced to the SP500 Intrinsic Value Index. This could occur again. The majority of investors in my judgment are trend followers.
Knowledge of market psychology is a very potent investment tool. Having one’s capital with the consensus view has always proven hurtful to one’s investment performance. When market psychology turns from one “BUBBLE” to the next, one needs to be properly positioned and informed.