(Frontier Asset Management) TINA! There is no alternative. This acronym is a reference to the idea that when savings rates are zero and the bond market only offers a pittance of return, investors will view risk assets as the only game in town.
However, 12 years into a bull run for U.S. stocks, one might be hard pressed to imply that U.S. stocks are reasonably priced at these levels. And, now with inflation heating up, we can add commodities into the mix of assets with prices approaching multi-decade highs. We are left with current price levels for stocks, bonds, real estate, and now commodities all implying lower future expected returns based on our analysis. Maybe the new acronym should be TINAA – there is no alternative to the alternative.
Shiller P/E – Oh Not This Chart Again…
Source: Multpl
Undoubtedly, many investors today must be looking into their magic hindsight rear-view mirrors and hoping for the parabolic returns of yesteryear to continue. Whether it be return chasing or TINA, investors have poured 20 years’ worth of net asset flows into the stock market this year. But, for this quarter, stock prices were muted. What gives? Maybe there is only so much hot air that can be blown into a balloon?
Of course, valuations are not just about prices. There are two sides to the valuation coin. The merit of an investment must also be considered, often stated as earnings, yield, sales, book value, rents, etc. The price to earnings ratio (P/E) is the most common valuation measure for stocks. While current U.S. stock prices are – by most measures –high, earnings have been surprisingly strong.
When a balloon expands, it expands in all directions – all sides of the balloon benefit. As stock prices rise, so too does the economy benefit. And what an economy we have had recently. Earnings have followed suit, posting positive surprises quarter-after-quarter.
Then again, let’s get back to why has the energy in the stock market seems to have waned? My guess is that investors are now questioning the trajectory of earnings. Whether it be wages that companies now must pay, a lack of workers, a shortage of supply chain inputs, or inflationary pressures, companies may be facing headwinds that can dull their earnings growth rates. And the “market” tends to price earnings changes long before they actually occur, or at least that is how it is supposed to work.
The hanging question is, can this earnings growth continue at this pace to drive stock prices ever higher, or has the easy recovery money already been made?
Key investor takeaway
While I waxed and waned up there, valuations do matter. The problem is that over short periods of time, valuations are typically not indicative of future returns (nor is past performance indicative of future returns). For equities, the idea that stock returns will be higher when the current P/E is low and lower when the P/E is high, is not linear for return periods less than about 10 years. In other words, for any given 5-year period time, stocks can act both rationally and/or randomly. However, wait long enough, and the valuation connection often emerges. This is akin to my declaration of “call me in 10 years and I will tell you if valuations were a good predictor of returns”.
Investors often don’t want to wait 10 years for capital markets to act rationally, or for valuations to ring true. Returns in the short run often drives investor asset flows. Throw in a big year, and the magnitude of returns acts like a magnet for capital.
The second assumption of the current high prices for U.S. stocks is that some investors may infer that the U.S. stock market is just about to crash. However, valuation data does not suggest this. Just because most market corrections have occurred while valuations have been historically high, does not mean that all periods of high valuations have led to market corrections. What the data suggests is that over longer periods of time, high current valuations lead to lower future returns, and vice versa.
Alternatively, market corrections in the modern era have usually been driven by surprise events or black swans, think COVID-19, or the Financial Crisis. The Tech Wreck of the early 2000s is the exception to this rule though. We recognize that there has been a general rise in the P/E for the U.S. stock market for the past 20 years, and for most of those years, the P/E has remained historically high. John Maynard Keynes once said, “Markets can remain irrational longer than you can remain solvent.”
What should investors do about these high asset prices? Probably nothing. The problem is TINAA. There is no alternative, and now no alternative to the alternative. Prices are high nearly everywhere, and likely to a similar degree across asset classes. But holding cash is losing to inflation at a rate of 5% a year.
Those with savings would, it seems, by necessity have to be investors. However, that doesn’t mean that investors have to act like speculators.
