Barron's Streetwise - Are Stocks Still Attractive?

Episode Date: August 20, 2021

Jack tackles listener questions, including whether investing has fundamentally changed. Learn more about your ad choices. Visit megaphone.fm/adchoices

With record levels of dry powder available for investment, find out what's in store for private markets in 2025 and beyond. Listen to Crafting Capital in partnership with UBS at partners.wsj.com slash UBS, Spotify and Apple Podcasts. Hello, I'm Jack Howe and welcome to the Barron Streetwise podcast. I will be out for two weeks of intensive summertime sloth, but I'm not going to leave your ears unattended. Let's make this a listener question special. I'll play a few of your cues. I'll try my best to supply some A's. Listening in is our audio producer, Jackson. Hi, Jackson. I'm here to supply the J's. Nice. I'm thinking if we make this a short episode, that will add scarcity value and it'll help offset any diminishment in quality from, say, the lack of guests. What do you think about that?

Sounds like Econ 101. So who do we have first? We have Scott from Greenville, Illinois. Hi Jack, I was going through my files the other day and came across an article that you wrote back in 2006. Think about it, that's before the iPhone was released. A lot has changed since then, but have the principles of investing changed between 2006 and today? Thank you, Scott. Your question is, have the principles of investing changed since 2006, or what you can call 1BI, before iPhone? Let's distinguish the principles from the backdrop. In 2006, inflation was elevated like now. Economic growth was brisk like now. Only back then,

it wasn't because we were bouncing back from a pandemic. That was near the peak of the housing bubble, so house prices had grown so high as to become discouraging for buyers. That's happening now, too. The latest reading on the K. Schiller Index of U.S. house prices showed a gain of more than 16% over the past year. Some things are different, though. some things are different though at this point in 2006 an investor who wanted to seek safety could buy a 10-year treasury note yielding close to five percent inflation at the time was lower than that closer to four percent today a 10-year treasury yields about one and a quarter percent, and the latest reading on inflation is over five percent. Now, we think some of that inflation is temporary, but it's unclear how much. Treasury buyers appear to

be willing to settle for sharply negative yields after inflation, and that means the choices facing investors seeking alternative to stocks today are a lot less attractive than they were in 2006. stocks today are a lot less attractive than they were in 2006. Two more things, Scott. U.S. stocks at this point in 2006 were close to their historical average valuation. The S&P 500 traded around 15 times trailing earnings. Now it's closer to 25 times. And if we go by projected earnings, it's still about 21 times. Also, cryptocurrency wasn't part of the picture in 2006. Whatever you think of it now, it's nearly a $2 trillion asset class. So have investing principles changed? For me, they haven't. Step one, of course, is still to generate long-term savings. Step two, assuming you have cash set aside for emergencies, is to

place a large portion of your savings into quality stocks, so long as you can afford to keep it there for a decade or more. All of the other steps are less important than these. Not unimportant, but less important. Seek out tax-advantaged accounts whenever possible. Keep fees low. Diversification matters, but many treatments of the topic make it sound as though more is always better. The truth is, a little goes a long way. One analysis by the CFA Institute found that when investing in large companies, there was little risk reduction gained by diversifying beyond 15 stocks. For small companies, 26 stocks was the optimal number. Of course, there's nothing wrong

with buying a low-fee index fund that tracks hundreds of stocks. Asset allocation is important. You should put some of your money into things other than stocks with the hope that if stocks tank, these other things will hold their value. Some people say the percentage you put in bonds is a function of your age, but strictly speaking, it's a function of how soon you might need the money. Warren Buffett once disclosed the investment instructions he gave to a trustee for his wife in the event of his death. He said, put 10% in short-term government bonds and 90% in a low-fee S&P 500 fund. If the dollar figures you're working with are smaller than those available to Warren, you'll probably want more than a 10% cushion. Elderly billionaires and their heirs can invest with youthful daring, because for most of their money, the answer to the question of when they'll need to spend it

is never. If you're a 28-year-old sole breadwinner with kids, a mortgage, and $20,000 in savings outside of your retirement accounts, don't put any of it in stocks. That's your emergency fund. Keep working hard and saving harder until you have enough cash to live off of for at least six months, ideally a year, and then start adding to an index fund. Scott, none of this has changed since 1BI. As for cryptocurrencies, I consider them speculative vehicles, not components of a long-term saving strategy. I hear many people saying, allocate 1% or 2% to Bitcoin. That's fine, but it feels like a bit of a dodge to me. Either Bitcoin is a compelling value at $45,000 for reasons we can articulate, in which case you should probably put more than 1% or 2% into it, or it's just something you buy

in hopes that other people will pay more amid all the excitement. In which case, pay for it out of your entertainment budget, not your investment funds. For me, the key to savings is still stocks. They represent businesses run by smart people. The whole point to investing your money with those people is that they can figure out how to profit as conditions change. I hope that helps, Scott. Hey, Jay, how about another cue? Sure. We have Chris with a K. Hello, Jack. I really enjoy listening to your show. I listen to it when I'm working out or working around the house. My dad turns 80 this year. I remember growing up reading Barron's

Magazine and charting stocks by hand on graph paper before it was so easy to do on computers today. My dad and I have a question. It looks like the P.E. ratio of the S&P 500 is skyrocketing through the roof. And if you chart it over time, normally it falls just as rapidly as it has rose. Is this time different with all the government money that's in the market? How long does this party last? And when do we think or where do we think the PE ratio of the S&P 500 will stabilize to? Thank you, Chris, and happy 80th to your dad.

As I mentioned earlier to Scott, the S&P 500 index traded recently at 21 times forward earnings, which is pretty high. The key is that market valuation is poorly correlated with short-term returns and highly correlated with long-term ones. In other words, just because the market looks expensive doesn't mean it won't continue running up for years longer. There's no way to accurately predict what the next year will bring, but it's a pretty good guess that the next 10 years will bring below-average returns for stock investors, because the starting point is an above-average valuation. Now, that doesn't mean you should sell out of stocks. Bond yields have rarely been lower, so there's a good chance that even if stocks don't do as

well as usual over the next decade, they'll still beat bonds. As for where the P-E ratio of the market will stabilize, there are some people who think the market's average valuation has permanently shifted higher because stocks as an asset class have become less risky due to factors like central banks acting to limit the scope of recessions. But I can just as easily make a case that we've been in a quarter century stretch of rolling asset bubbles that only make it look as though the market's average valuation has shifted permanently higher. the market's average valuation has shifted permanently higher. The truth is, there are a few historical parallels for now. The combination of elevated valuations, near-zero interest rates, large spending programs,

the ongoing pandemic, shortages of key goods like cars and houses, and so on. If you want my best guess, here it is. I'm guessing the average market PE will ultimately revert downward to a number in the mid-teens, that the average market return over the next decade will be a mid-single-digit percentage, and that the period will include at least one terrifying sell-off that tests investors' confidence about whether stock investing still works. If you owned an S&P 500 fund in late 2007, you had lost half your investment by early 2009. But you've also more than doubled your investment, nearly tripled it really, if you've held on until now. Let's do one more, Jackson. Who's up?

We have Fritz, and he has a problem that I wish I had. My name is Fritz. I live in New York City, and I love a problem that I wish I had. known in popular parlance vulgarly as f*** you money. So I'm wondering, Jack, if you were in my shoes, what would you do? Bonds don't seem like such a safe bet anymore because of rising yields and stocks are so volatile. Some of my friends have mentioned to me to invest in real estate as a hedge against inflation or even expensive art. I hope you answered my question, mostly because I think it's high time that somebody gets bleeped on your show. That's actually the one thing that I think is missing, a little bit of edge. Fritz, congratulations on the sale of your business for F-U money. My first recommendation

is for a hedge against inflation, F-ART. Now that I hear myself say that, I realize it spells FART, but let's not let that distract us. People like to call anything that's gone up in price a hedge against inflation, but there's nothing about price gains in fine art that has specifically resembled the inflation rate in recent years. Fine art is a speculative vehicle that's nice to look at and to show your friends, and that can be pretty expensive to care for depending on what we're talking about. Now, real estate sounds better, and I'm sure you need some bonds, but Fritz, think about what got you here. A business. So why not buy another business? In fact, buy small pieces of a lot of different

businesses that you don't have to show up to work for. And yes, I'm talking about stocks. I know they're volatile, but Fritz, I'm guessing so was your business. We just couldn't see the volatility because maybe it didn't have shares that traded on an exchange. But I bet there were days that you thought you were killing it and a few maybe early on where you felt like you were getting killed. If I had asked you each year along the way how much you thought your business was worth, I bet I'd have gotten some wildly different responses from year to year, rising to an amount that was larger than you imagined you would reach. I think you should stick with what's working, only with more diversification and less effort

by putting a large portion of your money to work in stocks or stock index funds. And just for you, Fritz, I'll try to mix in some edgier language on the podcast. Jackson, what in the fudgesicle do you say we cut the Bill Shatner and get the Fraggle Rock out of here? I'm not sure I follow. Well, you're just not as good at salty language as me and Fritz, but I still like you, you crazy son of a cheese and crackers.

Thank you. Thank you, Scott, Chris, and Fritz for sending in your questions and everyone, please keep the questions coming. Just tape on your phone, use the voice memo app and send it to jack.how that's H O U G H at barons.com. Subscribe to the podcast on Apple podcast, Spotify, or wherever you listen to podcasts. If you want to find out about new stories and new podcast episodes, you could follow me on Twitter. It's a little bit hit or miss. Some days I tweet.

Some days I don't give a Donald Duck. Pardon the sassafras. It's at Jack Howe, H-O-U-G-H. See you next week.