There are many scary news blasts these days leading up to the Holidays. This article is to give you some respite from those unsettling financial stories and to talk about something truly as dramatic, yet is little talked about in the media. Still, it’s very important for you to know if you are to be financially astute and successful.
Rather than ‘the troubles’ (as the Irish would call some of their darkest moments), what if we actually were watching the world succeed, and on the verge of a long-term rally in stocks?
First, let’s address the elephant in the room; the current policies and debt levels of developed nations are unsustainable. Please remember last month’s primal message; Risk = Return. The problem is that the returns of these government bonds have historically been low, as sovereign debt is nominally considered ‘risk free’. That debt is simply not so ‘risk free’ any more. All the issues of Europe’s possibly de-Euroization can be directly attributed to debt (not right wing or left wing governments, per se). Money doesn’t care about political leanings. At your upcoming Holiday gatherings if you want to sum up the current world state and be succinct as you do so, simply ask for 18 seconds and give two quotes. As Will Rogers once famously quipped; “I’m not worried about return on my principal. I’m worried about return of my principal.” Follow that quote by another, coming from former White House economist Herb Stein who said; “If something cannot go on forever, it will stop.” Pretty powerful comments, don’t you think?
So the 20-30 year bull period of bonds may be coming to a close. Bond yields are also very low, but staying shorter duration (as you are in your portfolio) is the best way to protect yourselves against spikes in the future. But where is an investor going to get the returns they need to beat inflation?
Here’s something to consider. Many equity investors have really had a miserable 10 years. In that decade, most of them would have constructed their portfolios to be filled with S&P type large companies, and as you likely know, that course would have left them roughly in the same place they started. But let’s look at where we’re currently at from a 30,000 foot level;
- The Price Earnings ratios now are roughly half of what they were then (14.3 vs. 28.9[i]).
- The profitability of companies is high by any historical measure.
- The current 10 year rate on Treasuries (bonds) is about 1/5th the earnings yield on the September 30, 2011 S&P index (2% vs. just shy of 8%[ii]).
The above recap says that equities are as under-valued relative to bonds than they have been in close to half a century! I don’t know when, or by how much, but I suggest the facts are pointing us to a far better next 10 years than we currently have media-mindshare to believe possible. Negative news gets priced into the stock market, and markets overshoot. Positive news also gets priced in and markets overshoot, but I think we can rationally say that we’re not overly buoyed with good news or sentiments toward our governments. Yet, companies keep on truck’en.
We’re not going to do any doubling-down, or anything of the like. However, we are going to let history take its course, and you are going to hold every great company until good news gets reflected in their share prices and not just their profits.
That reality could make a very nice 2012-2016. Merry Christmas.
[i] “The Long View” (American Funds, October 2011)