Keep calm and carry on.

Keep calm and carry on

Getting desperate from reading opinions on how the markets are going to evolve in the (near) future.

Only this week I read two completely opposite opinions in the press.

On one hand the outcome of the elections in the US and news about corona vaccines made JPMorgan state his bullishness about the S&P500, which they expect to rise by 25% by the end of next year. On the other hand, I read a study by GMO Asset Allocation Insights, but it is one amongst many, that stated that stocks and bonds are pricey and forecasts another “lost decade” for a traditional 60% stocks/40% bonds benchmark portfolio.

I recognize that stocks are currently expensive by historical standards.

A CAPE ratio of around 30, as is the case today, historically predicted returns of the S&P500 for the next decade, well below 4% yearly.

(CAPE ration is a price/earnings ratio where the price of a share or a market is being divided by the 10-year average, inflation adjusted earnings. This use of average earnings over a 10 year period, is intended to smooth out exceptional fluctuations as is currently the case with corona)   

But on the other hand, if you would have done the same exercise in 2010 the CAPE ratio, at that time, forecasted a return for the period 2010-2020 between 6.2 and 8.2%. The effective, average yearly return of the S&P500 during that period, turned out to be much higher. It mounted to a staggering 14.45%. Anybody keeping lots of cash on the sideline, to step in after a major correction, had huge opportunity costs. (This is money you could have made, but you did not)

The reason for this surprising movement and for the markets being expensive, by all criteria, despite the uncertainty of the economic consequences of the corona crisis?  Clearly TINA (There Is No Alternative). Financial repression from the side of the central banks lead to record low interest rates on bonds and savings accounts so all investors and pension funds turn to shares in order to get a return on their investments.

Was the surge in return generalized? No, it were especially the growth shares that took the lead. This movement became even stronger since March 2020 where the growth, high tech, stocks surged ahead. Growth stocks within the US Russell 1000 index increased between March 23^rd and August 31^st of this year by 77%. Beating value stocks by 32%.

Inside the S&P500, value stocks have unperformed growth stocks by 2.86% on average in each of the last 10 years.

What we saw this week, after the positive news about the Pfizer vaccine, was a movement in the opposite direction. Tech shares corrected somewhat and more traditional shares, especially in travel and other “fun” sectors surged violently upwards.

Is this the start of a wide move in which we should participate? Selling growth shares, fund and ETF’s, dominated by tech shares, and re-invest the proceeds in value shares? Or should we, after taking profits on growth shares, stay out of the market all together, in view of the high multiples in Price earning, Cape ratio, Price-Book value, you name it, and wait for better opportunities to get back in?

I would advise against getting (partially) out of the market and trying to time the market. The sudden surge in non-tech shares this week has demonstrated that trying to time the market can be a very costly affair if you happen to miss the best days. Also it is estimated that over 4 billion dollar is still on the sideline waiting on a better opportunity to get back invested. With so much cash waiting for an opportunity, no correction will be long lived. This is what we saw in March/April this year. It will take a very big “Black Swan” event to push markets down in a sustainable way. Bear in mind that in Emerging markets a rising middle class is also keen on investing its savings.

40 years ago, the principal concern of a Chinese worker was how to survive. Now, after paying for his middle class life style and holidays he often still has a remnant from his salary he wishes to invest.

So, I would be careful in selling investments in growth shares. I personally took some profits in recent weeks but on a very limited scale and only in the “satellite” part of my portfolio. I do not intend to sell global ETF’s like the MSCI world, despite them being heavily invested in the US tech shares.

You could rebalance your investment by steering money for new purchases somewhat towards Value, Dividend Aristocrats, Cyclical and Quality shares. If you are heavily invested in expensive growth shares, I would say this is a good time to take some profits of the table and re-invest them in the above mentioned sectors. In Belgium the founders of a specialised textile company; Sioen, decided to delist the shares of their company. They did not so this believing the company was overvalued. Rather the opposite. So a catch up of undervalued Value, Dividend, A rebound of Cyclical and Quality shares is imminent when corona will release its grip on our societies. But not before.

(For a share to be considered a Dividend aristocrat it has to increase its dividend for 25 consecutive years.)

A cyclical rotation, in favor of the above-mentioned categories, will probably last for many years. Bear in mind that historically, Value outperforms Growth and Momentum. On 30 September 2020 the average Price/earning of the shares in the Russell 1000 growth 34,10 or around 50% above its average of the last decade. The average Price/earning of the shares in the Russell 1000 Value was 21.7, still 36% above its average of 15.9, but in the Value index figure a lot of energy, commodities and natural ressources shares that should benefit from a post-corona normalisation. Of course,the figures demonstrate that TINA pushed the prices of all sectors above their historical averages. But TINA is not going away any time soon.

Also geographically, you could buy a bit more ETF’s/funds in the cheaper Emerging markets. Especially as the corona virus will still ravage the US and European economies for some months to come. Markets such as Russia, China and South Korea appear still more reasonably priced than the US markets so, yes, you could direct some investment money also that way. How to go about this practically? Well you could buy some ETF's that specialize in Value, Quality or Dividend shares. You will find some examples on my page on the core portfolio but also the ETF finder on the Morningstar website will lead you towards such ETF's. You could look for some individual holdings that invest more in these shares. Solvac, a monoholding above Solvay, is a good example allthough a monoholding is more risky than holdings that invest in multiple companies. Ackermans van Haren would also qualify in Belgium.

I would still stay away from bank sector shares. A wave of bankruptcies in the restaurant, hotels and other related services is still to come and what we currently see in the US is that a combination of corona, violence and high taxes chases people out of cities like New-York towards the country-side and/or smaller provincial towns. This movement, which will also happen in Europe, could lead to losses on mortgage credits for real estate in those city centers. Bad news for banks.

I would also ignore the argument of ESG investing whilst selecting products. (ESG = Environmental, Social and Governance) It is a craze of everybody wanting to look politically correct. Waist of ink and time.

Traditional oil companies are now considered dead and buried but remember, usually within 5 years after a sector is declared moribond, it comes back with a vengeance.

So in conclusion, if you have a balanced core portfolio, no need to make drastic changes. When the vaccines will prevail over the corona virus a lot of relief spending may be coming our way and battered cyclical shares may catch up with their growth colleagues. However, do not write off technology too soon. But if you have a balanced portfolio, like I advise, you will still be invested in a lot of growth and tech companies through your ETF's, funds and holdings. Just continue to invest regularly, put some of the above-mentioned accents for your new purchases and rebalance a bit if you are heavy on growth stocks. The dark period at the end of the year is also a good moment to compare your portfolio with your financial plan and eventually do some re-balancing. After the rally of the markets of the last week, based on the combination of a Democratic president together with a potential Republican majority in the senate and good news about the vaccine, I would not rush to put loads of extra cash in the markets. Better occasions may come in the near future.

Stay prudent, use common sense but do not forget to enjoy your live. I personally have  no intention to stop travelling.