Many investors might be feeling a bit like Alice in Wonderland as they relate the feeling of fantastical events in today’s investment environment. Similar to Alice, the boredom associated with the hum drum of market cycles often lull investors into ignoring signals of reality around them. Like Alice, investors might find themselves succumbing to the “BUY ME” and “SELL ME” signs that pepper today’s investment landscape. So, what is the answer? My opinion is to face reality and save adventurism to romantic vacations and to leave it out of your investment portfolio. In other words, don’t get too cute!
It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. – Charlie Munger
Are US stocks near a top or poised to go much higher?
For regular readers, you know my answer to this already–no. There are a lot of reasons I think this is the case but I’ll try to focus on a couple I’ve not mentionedbefore. Here they are: US dollar strength and US corporate earnings. With the US set to raise interest rates (however slow or quick) and other major economies set to lower interest rates (e.g. Europe, Japan, China, etc.), this differential causes inevitable currency wars. Consumption and demand for goods and services drive the economic engine of all economies and ultimately each country wants to gain an advantage (usually through trading) in that equation. Typically speaking, higher interest rate economies will attract capital thereby driving the value of a particular currency higher. Speaking for the US, this makes the dollar relatively expensive to other currencies causing less goods and services to be demanded which affect US companies looking to make profits. Stressed profit margins lead to layoffs and economic slowdown. Investors should be focused on monitoring this cycle and how corporate earnings fare in the interim. Here is a chart of the US Dollar Index (DXY), since the recession. (courtesy of BigCharts)
What asset classes are still reasonably priced?
I will have to be very careful here since the operative word is “reasonably”. I will confess though, that experienced investors that have had some semblance of victory in several market cycles agree that everything is not expensive–just most things. I’ll be upfront and just give away the secret–focus on total return. Ultimately, you want every dollar you invest to return more than that dollar. One of the simplest ways to do that is to find investments that pay a dividend or an interest payment. Naturally, this would turn your focus to dividend-paying stocks, real estate investment trusts, fixed income, or funds that invest in one or all of the previous categories. Within that universe, you can begin to identify asset classes that are historically cheap. “Historically cheap” would be defined as something that hasn’t been seen in at least one market cycle (e.g. 7-10 years). A good example (and much publicized lately) are high yield bonds. Because of the energy crisis that began in late 2014, yields (inversely related to prices) on this asset class started to rise during 2015 and peaked in mid-February 2016. Although these levels sometimes signal default-like risk, for some investors it presented an opportunity to invest in a basket of securities (paying current income) in hopes that a few deeply discounted investments would handsomely reward their courage and patience. Here is a chart of the iShares iBoxx High Yield Corporate bond ETF (HYG) since the recession. (courtesy of BigCharts)
As my grandmother liked to say, “Baby, keep the main thing, the main thing”. I think these are words to live by, because as an investor your main goal is to grow your capital. It often doesn’t pay to try new things and fall down the rabbit hole like Alice. What makes more sense is to stick to what you know and understand, to focus on total return, and to exemplify patience and discipline.