A few years ago, TINA was everywhere … she was the life of the party. Whenever people wondered why stocks kept rising, she’d show up and people would scream, TINA!
But I haven’t heard anyone mention her recently … did she take off? Or did she drink so much from the punch bowl that she’s passed out, sleeping somewhere?
Of course, I’m talking about TINA the acronym, not Tina your old drinking buddy. As in, There Is No Alternative … to stocks.
Let’s be clear. Choosing your investments by process of elimination is not the best way to approach things. After all, you shouldn’t invest in something just because everything else looks worse. That investment could also have little intrinsic value and a poor risk to reward ratio.
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But TINA is not a way of investing, it’s a narrative … one that’s been with us for years and may be here for a while longer. So far, this narrative has helped investors achieve substantial returns. Will it continue to do so moving forward?
For most investors, the highest level asset allocation decision typically involves deciding between stocks, bonds, and cash. Let’s begin with these three and then we’ll expand our discussion to encompass alternative asset classes such as precious metals, real estate, and currencies.
Since stocks are the shoe-in here, let’s take a look at cash and bonds to see what type of case can be made for investments there. First cash.
As you well know, the returns on cash have dropped to zero over the past couple of decades. The chart below exemplifies this, showing how the return on savings accounts has dwindled since the early 90’s.
When you take into account that inflation has been running between 1-2 percent in recent years, this means that cash currently generates a negative real return. That is, while your account balance may stay constant, the purchasing power of that money is declining.
But cash has a big benefit from an investing perspective; actually, two big benefits. The first is that it has very low volatility – also known in the investment world as a risk. If you have a lot of money tied up in cash, you may lose it slowly over time to inflation, but you won’t lose it quickly as you could with stocks or other investments.
The other oft-forgotten benefit of cash is that it’s the mechanism through which other investments are accumulated. Without cash, you won’t have the means to acquire other assets when their prices are favorable. Thus, cash positions are to be managed, not avoided.
The other primary option investors have at their disposal is bonds.
Bond holders can make money in two ways: They receive interest payments based on the coupon rate of the bond(s) they purchase, and the market value of those bonds can rise IF market interest rates decline.
Let’s take these two, in turn, to see what prospects lay ahead for bond holders.
Right now, one of the largest bond ETFs available – AGG, which tracks the Barclays US Aggregate Bond Index – currently yields 2.5%. Subtract out inflation once again (which is running at around 1.5%) and that leaves you with a solid 1% real return! Hey … at least it’s positive!
But that return doesn’t take into account changes in the market value of those bond holdings, which fluctuate as market interest rates rise and fall. Specifically, the market value of those bonds will rise if interest rate fall, and fall if interest rates rise…
Which do you think is more likely?
Personally, I tend to think we’ll be stuck in this low-interest rate environment for many years. But the prevalent view is that interest rates will rise slowly as inflation creeps back into the economy and central banks normalize monetary policy.
If that view pans out, many bond holders will see the value of their bond portfolios fall by more than they can recoup through the interest payments. Said differently, nominal returns could very well turn negative, which means real returns would be even more negative.
While we’ve been talking about this situation for many years here at DTL, it’s a situation that many investors still don’t understand … or at least, they don’t recognize the gravitas of.
If you have or are planning to keep a large portion of your portfolio in bonds, let me make one plea to you: BUY INDIVIDUAL BONDS, NOT BOND FUNDS.
While purchasing actual bonds is much more difficult, at least they will guarantee you the return of your principal (assuming, of course, the issuer does not default). With bond funds, there is no guaranteed return of principal.
Read that again. The biggest benefit of owning high-grade bonds (nearly guaranteed return of principal) DOES NOT APPLY to bond funds. Instead, bond funds work more like ETFs … the value is wrapped into the share price, which will fluctuate heavily over time. If market interest rates rise, share prices of bond funds will plummet, and you’ll have no way of recouping that loss.
Okay, now that I’m done harping on that issue let’s get back to the topic at hand: TINA.
At this point, you should be recognizing that TINA is very much still a part of today’s market narrative. Not much has changed from an interest rate/deposit rate perspective and therefore the future prospects for both cash and bonds remain lackluster at best.
So then, what about stocks?
Stocks are even more expensive now than they were a few years back when everyone said they were overpriced and used TINA as their excuse for investing in equities.
Recognizing that stocks were the only alternative back then were a good and profitable move. Is that still the case today?
My answer is a hesitant yes.
To keep things short and simple, I’ll only provide you with two justifications for this … but they’re really the only two that matter.
First, corporate profits are rising and the outlook remains healthy. As you should know by now, corporate profits are the lens through which all information should be filtered and interpreted. The only reason any “news” matters, if it does, is because it impacts the outlook for corporate profits moving forward.
Right now, with corporate profits rising, the present value (as determined using a discounted cash flow or similar analysis) of companies is increasing. Said differently, companies are becoming more valuable because they’re generating higher earnings and cash flow streams. This means that their share prices will adjust accordingly.
Beyond that, we need to look to the broader economic landscape to determine whether approaching conditions will be conducive for continued growth in corporate profits (I told you … everything always goes back to profits).
Right now, the US economy remains on stable footing and our expansion continues at a slow but sustainable pace. That provides a good backdrop for equity prices, but the global landscape is improving as well. Since nearly half of S&P 500 revenues come from overseas, this is an important consideration.
As discussed last week, leading indicators for major economies around the world are pointing up. If the global growth surge continues, it will act as another tailwind behind stock prices, ensuring that those earnings streams can continue to grow.
In conclusion, while stocks remain expensive by historical standards, at this point they still have one of, if not the, most favorable outlooks among the major asset classes. Stocks currently provide a similar yield to bonds, and yet have much better prospects for future growth.
The preceding content was an excerpt from Dow Theory Letters. To receive their daily updates and research, click here to subscribe. Matt is also the Chief Investment Strategist at Model Investing. For more information about algorithmic based portfolio management, click here.
