Between the D-2 and D-3 college lacrosse championships and the Red Sox game it took some masterful Tivo work to take in David Swensen's appearance on the Connie Mack show (the show is on Sunday afternoons in Arizona).
I'll write more about the appearance later but as Swensen was talking about diversification and the high regard he has for TIPS I started thinking about the debate over whether we may or may not have big inflation or serious deflation, whether equities are dead and all of that I thought it might be worthwhile to explore a the notion of a non-equity portfolio.
It should be no surprise than many people are in the process of giving up on equities. As Eddy Elfenbein mentioned, equities are down 39% decade to date so it is reasonable to ask a few questions.
If you are going to give up on equities you still have to address the potential loss of purchasing power. If deflation wins out over the next few years, ok, but at some point inflation will matter again. At a 3% inflation rate our expenses will go up 50% in 15 years and if some inflationistas turn out to be correct 3% inflation will fall short of reality.
Avoiding the stock market can't mean all cash. The obvious answer might be all TIPS. Well maybe but the idea of 100% in any single type of thing no matter how "safe" seems straight up crazy to me. I'm not likely to be the guy to see the complete breakdown of how TIPS function ahead of time but anyone can avoid having a complete breakdown wipe them out by not going 100%.
Obviously part of the inflation story would be the dollar getting weaker against other currencies. This makes a lot of sense but just as it seems obvious, what might the US dollar do in the face of some sort of geopolitical event? Just because the US seems willing to let the dollar devalue does not mean that five years from now there can't be some sort of big dollar rally, like in 2008, even if it is counter trend. So putting everything into a basket of foreign currencies (either just the forex or via t-bills) is not something I would do either.
Commodities will very likely be a big part of protection against eroding purchasing power. If you read enough articles you will find recommendations for 20% or even more in commodities. I have what I think of as a lot of exposure to commodities and that is in the low to mid single digits (which is very low to some folks). If someone can stomach the volatility of 20% in commodities why not just have some equity exposure? While its is true that commodities cannot go to zero the plight of crude oil over the last year shows us they can go down 70%.
Some combination of all of the above and (with a nod to Jim Rogers and Marc Faber) a little farmland will allow for sidestepping some of the vagaries of equity markets like bad earnings reports, poor management decisions, options scandals and the like. However, avoiding equities does not mean avoiding diversification, does not mean avoiding home work and does not mean avoiding volatility.
While some folks may not want to hear this, I think avoiding equities in the context of this post is a mistake. We've endured a bad run. That bad run may have more to go but the equity market has had bad runs before and after the last two events like this one the stock market skyrocketed. Maybe a better plan is to tell yourself now that you will sell your stocks when the S&P 500 gets to 3300. Think that's nuts? Well maybe it is but from a low of 96 in April, 1942 the Dow went up (not in a straight line) to 987 in January, 1966. Then from a low of 808 in July, 1982 the Dow went to a high of 11,700 in January of 2000. So SPX going to 3300 would be a five bagger off the low compared to precedent for ten baggers.
To be clear I do not think equities are forever broken and if the SPX were to go up five fold over the next 20 years I would expect foreign markets to do much better than that which is why I have been planning to increase my foreign exposure slowly but steadily.
8 comments:
Hi Roger, I have agonized over the problem of equities for several years and have not reached a clear answer. I would like to point out one omission that seems to be in every analysis that I have read, including yours, on the subject. The argument of "equities for the long haul" or something similar usually contain two flaws. First and frequently the analysis "selects" a time frame to fit the argument. If not making money in ten years does not bother you what would? Two years, even three years, I could understand, but to follow a path that over a sustained period produces a loss is not in my DNA. That pushes the argument in the direction of market timing which is a whole different discussion.
The second problem is that people live finite lives. Telling me that equities may lose money over the next ten years (I am 72) is not a pleasant thought. Money managers step around this situation by advocating more fixed income with age, but why would you want any equities? Why would I want even 10% in equities if I thought that has a reasonable probability of losing money by the time I am 82?
The money management profession has a lot to answer for. I have used money management services in the past and have fired each of them for various reasons. I have learned over the years that investing is work and there is no substitute for active management and I mean active. Things change and buying and selling as things change is a lot of work but it is one way to keep ahead of the game. Buy and hold was not a strategy that has worked in my investment lifetime (1973 to the present)without buying and selling. I live off of my investments which means that each year I draw down a small percent, usually 3-6% depending on circumstances. Sitting through a 40-50% sell off is not an option.
In general I believe your approach is too diversified and lacks focus. I have no idea what your portfolio performance has been but I imagine your clients have suffered in the past two years.
Regards,
Jim
PS - I do not believe TIPs are the answer.
Jim:
I am 56, still work, and ditto your first three paragraphs. I bought TIP's and made money from them, but not from inflation, just falling interest rates. Lucky, not smart. I don't trust the gov't. to reflect the true rate of inflation.
What have you done that has been successful during the past two years, and what are doing to position yourself for the next five years?
Sam
Sorry to argue but equities are not down 39% over the last 10 years, Roger, developed economy stocks are.
Property isn't, commodities aren't, foreign emerging country stocks aren't, inflation isn't, collectibles aren't. Nothing has been crashing except the stocks of developed economies, as their profits have been cut through increased competition (via globalization and the internet) and diversifying into riskier, but ultimately more profitable, emerging markets.
We are taking a breather, now, and seeing who will be the winners and the losers in the first match in a World-sized game of Win the consumer (Step forward Google).
But it is just a breather, and will last as long as it needs to. The Players will regroup, take stock (no pun intended) and put the refreshed and newer talent to good use in the second round. There will be further wars (small), skirmishes and general tom-foolery dedicated to outwit the other players and gain more market share and influence, just like there has been in the past.
Meanwhile, the governments will continue to reassess how much they can take from us and then, as an aside, put it to some use - their power relies on how big their budgets are, after all, and not how they use it.
And we investors - large and small - will continue to look at new trends and try to decide if they have legs or not. It is impossible to predict the future as we never know exactly where we are in the present, so this is a tricky task.
Just some random thoughts of my own, Roger.
PS To Jim, you're agonizing over equities? You've been invested through the greatest bull market of all time and quitting whilst ahead would be a lot more sensible than some other alternatives. All respect to you, sir, but surely you've worked hard enough to just enjoy life now?
another good one RR.
So Jim Rogers and Marc Faber have discovered farmland? About 20 years late in my view. Roger, could you publish a graph of farmland values going back 20 years. I think you'll find the curve fairly steep. In our area, farmland is "fully priced" now.
Farmland has done well over time, but I still think it is a good place to be. If you are careful on the way in you can get 5-7% rents and still have the inflation hedge. Jon
Per Jim... the problem with equities is the fallacy of time diversification. http://homepage.mac.com/j.norstad/finance/risk-and-time.html
Compounding is great but it is a geometric progression and a zero tossed into the series leaves you at zero. I think only five currencies didn't default in the 20th century.
People in the US don't fully appreciate how wrong things can get.
I don't think that it is possible to invest in equities without some sort of timing -- although I would say that "bottom up" value investing is a form of timing.
Diversification took a beating this year also.
My favorite inflation hedge at the moment are some reasonably cheap floating rate preferred stocks. Inflation would both improve the credit and the cash flow. Inflation bails out both borrowers and lenders. However, for obvious reasons, I can't take a large position.
Equities are relatively cheap at the moment and have a pretty good 10 year prognosis.
You should have some cash. The US dollar isn't cash. Gold is cash.
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