The over-valuation of the U.S. stock market is one of the major investment themes (and truths) of the day. If history repeats, the U.S. stock market funds, and many U.S. stock portfolios will find it difficult to eke out any real return (that factors in inflation) over the next several years or decade. Another theme that gets plenty of digital ink these days is inflation. And the worst type of inflation is stagflation when we have a no-growth environment with an ever-increasing cost of living. We’re buying U.S. stocks and looking at stagflation on The Sunday Reads.
There’s no doubt that the U.S. stock market is very expensive. It surpassed the valuation levels of The Great Depression and it now rivals the lofty heights set in the lead up to the dot-com crash of the early 2000’s. You might remember that the high valuation levels led to the lost decade for U.S. stocks, when they delivered no real return for over a decade.
At high valuation levels that means you are not buying a generous earnings yield. Stocks are expensive. Earnings do matter over time and in fact contribute to 80% of the earnings probability.
And here’s the real earnings yield. It’s negative, but certainly the next few quarters of earnings could see the yield peek into positive territory. Once again, a real earnings yield is the underlying earnings yield of the market adjusted for inflation.
That said, growth might not be enough, and inflation might continue to make real returns a challenge.
You don’t have to buy the market
As a self-directed investor (or advisor) you don’t have to buy the cap-weighted U.S. stock market. Cap-weighting means that the biggest stocks get the biggest weighting in the fund or portfolio. It rewards momentum and enthusiasm, earned or not.
Here is a wonderful post on the dot-com era …
And here’s a great chart that shows the equal-weight version of the S&P 500 during the dot-com era, and crash.
An equal-weight strategy will assign an equal-weighting to the 500 stocks in the S&P 500. It does not reward momentum.
That strategy also outperformed the cap-weighted market through the financial crisis of 2008-2009. The strategy likes to outperform coming out of recessions and corrections.
For ETF investors it is available by way of this Invesco ETF. You’ll find that ETF mention on the ETF Portfolio page. Keep in mind that the Invesco ETF is a U.S. dollar fund. There is no Canadian dollar version available.
If you hold a portfolio of individual stocks you can simply look for value within the individual names. That is, more generous current earnings in tandem with growth prospects. I recently added to BlackRock in our U.S. stock portfolio. I am also looking to add new monies to our CVS that you’ll find in many U.S. value funds. You might also look for U.S. value ETFs if you’re concerned with market valuations.
That link offers a first half of 2021 review of our simple market-beating approach.
You might also look to U.S. dividend funds for more sensible valuation.
What about your one ticket?
The good news is that the automatic rebalancing would have been trimming U.S. stocks and moving the proceeds (generous profits) to Canadian and International markets where there is greater current earnings and perhaps that illusive value. Canadian markets are near historical valuation levels.
If we do get a generous correction in U.S. stocks the rebalancing mechanism might then be reversed with sales from Canadian and International stocks (plus from bond holdings) to buy U.S. stocks as they ‘go on sale’. Investing is about the discipline and activity through complete market cycles, from the correction and through any stock market recovery.
That said, the high valuation levels are likely to be a portfolio drag if we do experience another lost decade. The self-directed investor that buys their own ETFs and stocks might be able to better stick handle though this U.S. valuation “issue”.
Should you become a self-directed investor?
Stagflation ate investors alive
That was one of the main themes in my MoneySense weekly, here’s …
That post includes a brilliant VOX link that takes a look at the period of stagflation (70’s and into the early 80’s) and how the politicians and central bankers today might learn from the policy response in the past. My MoneySense weekly also looks at the current earnings season and the “buy the dip” notion, or fantasy. Thanks to Mike The Dividend Guy for that one.
What worked during stagflation? It was certainly not stocks. Surprisingly even the resource-heavy Canadian market could not keep up with the pace of inflation. It failed for a decade or more.
Gold and other commodities and energy stocks were a natural and expected hedge. In fact the price of gold increased almost tenfold in the stagflation period. You would not have needed much to somewhat ‘save the day’.
There were two major investment failures for investors over the last 50 plus years. Stagflation could have been covered by commodities and resource exposure. The damage from the dot-com crash could been avoided by avoiding those expensive stocks.
Will investors learn from the past?
More Sunday Reads
I will leave most of the reads of the week to Mark at My Own Advisor. There’s a very good round-up in that post, from podcasts to blog links.
Thanks Mark, that will save me time, ha. We have to get on the road to finish our trip to Halifax (to see our daughter). We can’t wait to see her of course. It has been over 20 months, thanks to travel restrictions.
On The Findependence Hub Jonathan Chevereau looks at how retirees can prepare for that ‘transitory for longer’ inflation.
Here’s the June report on all about the dividends.
That’s it for today. We’re on the road to Halifax. Here was our wonderful view last night, from our hotel deck in Ville de Rivière-du-Loup.
That is a site that every Canadian needs to see.
Thanks for reading, we’ll see you in the comment section.
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