This is the most divided, most murky stock market in memory. Many investors are betting huge amounts on the belief that artificial intelligence is going to supercharge the economy. Some prominent skeptics, though, see nothing but froth and hype.
Warren Buffett is the best-known doubter. The Oracle of Omaha has built the cash reserves at his Berkshire Hathaway Inc. to a record US$358-billion. He has been steadily selling stocks in recent quarters. All this suggests he doesn’t see much worth owning at current prices.
Michael Burry is another noteworthy naysayer. The U.S. hedge fund manager gained fame when journalist Michael Lewis made him a central figure in his bestselling book on the 2008 financial crisis. The Big Short told the story of how Mr. Burry defied many of his backers and placed a massive bet against the U.S. housing market just before the housing bubble popped. His contrarian gamble worked out brilliantly.
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Now Mr. Burry is once again warning of a bubble. He recently closed his hedge fund, saying that the stock market’s estimation of value no longer matches his. This sounds rather worrisome.
So, should you follow these venerable pros and head for safety? The answer has a lot to do with your personal situation.
If you’re older or if you will need to tap your money over the next couple of years, a bit of caution seems like a fine idea. You might want to consider raising cash, putting more money into bonds and avoiding the most hyped sectors of the market, such as the Magnificent Seven tech giants.
Stock market returns over the past five years have been all about the
Magnificent Seven tech stocks. (Magnificent Seven stock returns vs.
Bloomberg 500 returns without the Magnificent Seven, 2019=100)
Bloomberg 500 without Magnificent Seven
the globe and mail, Source: Apollo chief economist
Stock market returns over the past five years have been all about the
Magnificent Seven tech stocks. (Magnificent Seven stock returns vs.
Bloomberg 500 returns without the Magnificent Seven, 2019=100)
Bloomberg 500 without Magnificent Seven
the globe and mail, Source: Apollo chief economist
Stock market returns over the past five years have been all about the Magnificent Seven tech stocks.
(Magnificent Seven stock returns vs. Bloomberg 500 returns without the Magnificent Seven, 2019=100)
Bloomberg 500 without Magnificent Seven
the globe and mail, Source: Apollo chief economist
For most of us, though, it has rarely been a good idea to sidestep stocks completely, especially if you’re investing for the long term. The tricky thing is maintaining a sense of balance in this topsy-turvy market.
Here are four questions that can help.
The first question: Are you being adequately compensated for the risk of staying in the stock market?
Robeco, the Dutch investing giant, predicts stocks in developed markets will return about 6 per cent a year over the next five years.
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Goldman Sachs, the Wall Street investment bank, has a similar view. It is forecasting 6.5-per-cent annual returns for U.S. stocks over the next decade and 7.1-per-cent annual returns for global stocks.
These aren’t horrible returns. However, they are far less than the nearly 15-per-cent-a-year returns that the S&P 500 index generated over the past decade.
The prospect of muted stock market returns in years to come suggests you might not want to be entirely invested in equities, especially if you factor in the risks that have put off smart investors such as Mr. Buffett and Mr. Burry.
This brings us to a second question: What are your alternatives to stocks?
The most obvious one is bonds. They are currently paying yields in the 3- to 4-per-cent range. That is a lower return than stocks might generate, but bonds involve far less risk. They let you sleep well at night and protect you from the possibility that the stock market could fall and stay down for years.
To be sure, many investors see bonds as just a temporary refuge. They plan to duck into bonds, then jump back into stocks when markets recover.
This could work. But it raises a third question: Do you really want to take on the risk of market timing?
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Would-be market timers often sabotage themselves by being late to buy into a recovery. Yes, they succeed in saving themselves from losses on the way down. However, they then sacrifice potential gains by staying out of the market when the panic has subsided and stocks begin to rise again.
Anyone who is feeling cocky about their market-timing abilities should contemplate Aswath Damodaran’s account of how he tried to develop a reliable trading rule to take advantage of the market’s mood swings. Prof. Damodaran, who teaches finance at New York University and literally wrote the book on how to value stocks, based his work on the Shiller CAPE ratio, which is often regarded as the gold standard of stock market valuation. The ratio measures current stock prices against their average real earnings over the preceding 10 years.
Prof. Damodaran looked at what would have happened over the past 50 years if he had sold U.S. stocks when the CAPE ratio indicated they were seriously overvalued, then bought back in when the ratio suggested stocks had returned to reasonable valuations.
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In theory, this approach sounded eminently reasonable. In practice, it fizzled.
No matter what levels of the CAPE ratio Prof. Damodaran used as trigger points for his buying and selling, all of his trading rules wound up sharing one thing in common: None of them improved performance over what an investor would have achieved by simply holding a standard 60/40 portfolio, composed of an unvarying mix of 60-per-cent stocks and 40-per-cent bonds. Trying to time the market always eroded the portfolio’s performance.
So this brings us to a fourth and final question: Why not just rely on a globally diversified 60/40 portfolio?
It’s simpler than trying to time the market, it ensures you have a healthy buffer of bonds and it diversifies your geographical risk. Instead of betting only on a frothy U.S. market and a relatively small Canadian market, it spreads your money into markets around the world, most of which are considerably cheaper than Wall Street.
Vanguard Canada and iShares Canada both offer low-fee versions of this 60/40 global portfolio. (The tickers are VBAL-T and XBAL-T, respectively.) These funds won’t protect you from every potential disaster, but they do offer a sensible approach to navigating today’s massive uncertainties. If you’re searching for a sane, middle-of-the-road strategy in this murky market, they are good places to start looking.
