Is TINA luring us to the abyss?

Is TINA luring us into the Abyss?

This month of September, most of the stock markets are correcting. What has increased most, has suffered the biggest correction. The tech filled Nasdaq has corrected by around 10%. So has gold but the S&P 500 and the European shares (Eurostoxx 50) have only corrected between 7.5 and 8.5 percent.

For a lot of Johnny come lately’s this correction is a sobering experience. It is never fun to see your precious gains melt like snow under a spring sun but unfortunately, corrections are an unavoidable part of the life of an investor. The saying is: in corrections, the men are separated from the boys and there is some truth in this.

Whatever the best intentions made, starting to doubt the sanity of your decision to invest your precious savings in the financial markets, is very human in times of a correction. When markets correct, most investors first buy some extra shares, ETF’s, funds or precious metals. Then as the correction persists and their new purchases all accumulate their losses, further doubts of their sanity creeps into the investors’ minds and usually at the bottom of a correction the volumes are pretty small indicating that not so much investors still have the stomach to buy. This despite the fact that it is at these moments that fortunes are made (or lost, if you liquidate your entire portfolio in disgust, usually at the lowest point).

What to do now? In my blog message of 22 July I forecasted a correction of around 10 to 15 percent which I judged be a good level to start nibbling again. That is just what I did last week but very prudently.

So every correction of around 10 % to 15% is a buying opportunity and then the markets resume their climb? Is it really that easy?

No it is not, unfortunately.

Like every seasoned investor (to which group I count myself after investing for almost 40 years) I currently cannot shake off a sense of unrest.

We all know that total wealth in society cannot grow faster than nominal GDP over the long term. (GDP = Gross Domestic Product being the value of all goods and services produced in a given country in a given period)

By most historical text-books’ valuation rules, shares are currently very expensive. Take Price/Earning (The price of a share/market/sector divided by its earnings or profits – so the higher the outcome, the more expensive the underlying asset), take CAPE ratio (the same as Price Earnings but calculating with 10-year average, inflation adjusted earnings so as to smooth out abnormal years such as this year), take price/sales or take market capitalization to GDP, stocks are expensive to a degree comparable to 1997 (just before the tech crisis) or to 1929 (we all know what happened then). This goes especially for growth stocks and in particular for the tech giants.

If you are a regular reader of my website, you know the reason for this: TINA (There Is No Alternative)

Investors, pension funds still needing a return on their savings, in order to avoid these slowly being eaten away by inflation, do not see an alternative to investing in shares. In other words, investors accept the prospect of probably low returns in the future because the alternative is a guaranteed eroding of their capital.

TINA has led investors to accept lower compensation for risk by paying ever higher prices for assets.

In doing so they discard the risks caused by the economic slowdown following Covid. (30 to 40% of the service economy may be wiped out – planes stay idling on the tarmac –hotels are largely empty– global trade is hugely suffering).  A lot of jobs are going to be lost and it will take time to repair the economy back to the pre-Covid level.

Feelings of envy towards the better off, that were already on the rise before Covid, are going to get worse and social unrest is on the rise.

But as long as the music is playing, you have got to stay on the dance floor because leaving the floor too early may imply missing the climax of the party when the girls take their bras off.

Investors always believe they will be able to leave the dance-floor in time when the music stops but in reality very few, if any, manage to do so.

Investors feel re-assured by the central banks, which are going to keep interest rates low for an unlimited time and will not hesitate to inject money in the system for governments to finance themselves without interest rates rising. MMT or Modern Monetary Theory this is called. As a result, investors have been “trained” by the markets that every correction is a buying opportunity. This reflex choked so far any correction. It even happened also with the Covid correction and it will probably also happen with the current mini-correction.

But eventually TINA is going to lead investors in the abyss or at least towards a long period of very limited returns.

The large number of IPO’s (Initial Public Offering meaning companies that go public and seek for financing by investors) and the large number of new small investors now stepping into the market make the alarm bells ringing a bit louder. When the little guy appears at the dish, the soup gets thin. (Flemish saying)

Too much capital is being invested in the same shares following the growing popularity of ETF’s in which tech stocks are well represented. A Biden victory could start a correction here. Pension and state investment funds rebalancing their portfolio after the recent market rises could also put downward pressure on stocks. And a sell-off in the big tech stocks could easily snowball into a 30% correction or more.

Is it going to happen any time soon? I do not know, but basically, now is not the time to take too much risks in equities.

But you are not reading this newsletter to hear me putting up an umbrella so that I can say at a later stage: “You see, I told you so this might happen” Plenty of authors already do so and then, with hindsight, claim they forecasted the crash. Bullocks, most of them also scared you out of the markets during the best boom years.

So what to do?

First, do not get out of the markets completely just because they are expensive. Do not even get out of the US markets. Even without big-tech, the profitability of US companies is higher than that of European companies. I would even advice you to stay invested in US and Chinese tech companies. They do are profitable, and carry very limited debt on their balance sheets and what is expensive can stay expensive for a while or even get more expensive. Remember, massive money-creation and financial repression (keeping interest rates low and thus stealing from savers), by central banks created a completely new situation. We do not know how it is going to work out long-time but probably the muddling-through will still last for a while so stay on the dance floor.

Be careful with ETF’s. Yes, they are a cheap vehicle but they also have their downsides. The most important being that large amounts of money are chasing a limited number of shares and thus pushing them into the stratosphere. Do not necessarily sell your growth and tech ETF’s but diversify sufficiently.

Buy some things that are out of favor. Energy, smaller shares from family-led enterprises, value shares that can still be found at reasonable prices, but again do not overdo it with value shares. They are much cheaper than growth stocks but they are also, in general, harder hit by the current crisis. Do not limit yourself only to shares with an apparently cheap valuation. Valuation criteria can be useful to determine if a market or a sector is expensive but do not work for individual shares. If you only would buy “cheap” shares you would never have bought Amazon or ASML or the likes and what a blow to your portfolio that would have been. So basically, continue to diversify and put some accents with your new purchases. Eventually, in good days, take some chips of the table but with moderation. A prudent Individual Investor rarely, if ever, drastically changes his portfolio.

Which accents would I put now?

Gradually invest some extra money in Emerging markets. By preference through funds and ETF’s in order to diversify sufficiently. No rush but add to these positions over time. When international travel will be possible again, you should make some trips to Asia, the sense of dynamism you feel in this region is overwhelming.

Keep a decent amount of cash. The world is in turmoil and interesting investment opportunities will come. Without cash you cannot take advantage of them. The fact that we are now in the biggest monetary experiment of all times can play out in any direction but it is undeniable that the recent gains on the markets diminish the chances of further rises and increase the chances of a large correction to occur. Covid reminded us that black swans do occur.

Invest some more of your portfolio in gold and gold related investments. Up to 20 % looks a fair amount to me but do not overdo it. Any conviction can prove to be wrong. Even when you believe inflation to re-occur, gold is not a perfect inflation hedge and the right entry and exit timing is important to make money on gold. From 1980 to 2019 the volatility of gold exceeded the volatility of stocks. But the opportunity costs of investing in gold (interest that you would miss if the money you invested in gold would have been put on a savings account or in bonds) are currently very low and the world is in turmoil so, yes, up to 20% seems a reasonable insurance.

Investing is not easy. When people think it is an easy way to some free money, then you should get worried and lighten your positions. This looks like a good moment to take some chips off the table.

However, looking at the world as an investor will also make you understand the world. You do not encounter interesting investment ideas by only following the exploits of Kim Kardashian. Continuously examining the world in search of new investment ideas is what I like most in investing. The European Union seems determined to go forward with its “The Green Deal”. Even without the EU and even in the case of a re-election of Donald Trump, a lot of (newly printed) money is going to be thrown at green projects. Companies delivering in this field are going to have a field day.

Finally as an answer to my readers who wrote to me expressing their doubts about the possibility of inflation re-occurring. Yes, the velocity of money stays low (the speed with which money circulates in an economy. If there is a lot of money sloshing around but the velocity is low, it will normally not lead to inflation).

However, I would be very astonished that in the longer term, all the billions injected by governments, and often distributed to consumers, would not lead to some degree of inflation. Currently in Belgium the government is planning, a drastic increase in government largesse’s including pensions and social benefits. This money is going straight into consumers’ pockets. It will lead without any doubt to higher taxes, which are also inflationary.

Politicians who claim that the green conversion will not cost the public any money are blatant liars and they know they are lying. For the time being, I hear lots of proposals to tax fossil fuels such as petrol for your car and kerosene for the planes you (used to) travel with. Not inflationary? Really?

Also, thanks to Covid, big government is on the rise. More regulations and more government interventions always result in higher cost of living. Moreover, the cost for health-care and social benefits is booming worldwide. At some stage Europe is also going to have to invest more in its defense and security.  Again more taxes or deficits in view.

While in the past governments and central banks tried to control inflation, this time they will let it run freely because of its ability to balance the exploding debt in the world. Inflation is as a hidden tax on savers for which politicians do not get the blame.

For them, inflation is the perfect solution. Say 4% for several years? Please be aware that at 4% inflation and 0% return on a savings account, as is the case currently, reduces a saved or inherited amount of 100 euro or dollar to around 46 after a 20 years period.

So, yes I maintain my advice to be prepared for some inflation in the coming years. It will take some time because the Keynesian view that putting more money in people’s pocket’s will drive up consumption and thus the GDP in a sustainable way has proven wrong in the past. If anything is to be learned from the Japanese experience, it is this. So inflation will result from higher wages and consecutive higher consumption but from higher taxes, government intervention and above all by the devaluation of the western currencies following loss of confidence in them.  Higher taxes also result in lower private investments and a lower productivity growth.

You can clearly see the impact of stimulus packages on the economy. When central banks and governments announce a new stimulus package, confidence in the future, and also in the markets, rises. Then when the stimulus wears off, GDP growth, confidence and the markets go down. If ever the end of government stimulus would come in sight, be weary and make some bigger adjustments towards more defensive assets. (Cash, Bonds, quality dividend stocks rather than growth stocks.)

Slowly preparing for inflation can include stacking up some gold but also commodities and inflation linked bonds (bonds of which the return increases when inflation rises). All this can be done through ETF’s.

So, I regret my message is not more positive but I truly believe the current period of turmoil in the world is not over. Governments and central banks can “kick the can down the road” for still a while and that is the reason why we still stay on the dancefloor but ultimately the endgame is approaching. A very disruptive period is ahead of us and please start to prepare yourself and your portfolio for this.

If you have debts, pay them off, save whatever you can and diversify your savings.

Ultimately, human ingenuity will prevail. Free enterprise and globalization will eventually lead us to a better future. Remember, at the start of the eighties 44% of world population was living in extreme poverty by World Bank’s standards. Currently it is 9%. What happened? The fall of communism and globalization. Even Western countries, currently in complete disarray, will eventually get their act together. They will (be forced to) reduce debts, adapt the social safety net so that it will lead people back on the labor market, rationalize immigration and start investing more into infrastructure, education, research and above all, restore the link between studying, working, saving, investing and reward rather than promote an “entitlement society”. Eventually this will happen, but not just now. I sincerely hope this switch can be made maintaining democratic institutions and not under some semi-authoritarian regime.

See you all next month.