IS THIS A TIME TO be fearful? In Berkshire Hathaway’s 1986 annual report, Warren Buffett wrote, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
Make no mistake: There’s plenty of greed on display right now, whether it’s bitcoin, nonfungible tokens, Robinhood traders, GameStop or special purpose acquisition companies. All of this has some observers talking of a market bubble. Indeed, I suspect much of this nonsense “will end in tears,” a phrase my mother often used when trying to control her four rambunctious children.
And yet, despite this frenzy of foolishness, I find myself comfortable holding a portfolio that’s heavily tilted toward stocks. In fact, since the stock market’s startling rally began 13 months ago, I haven’t rebalanced my portfolio, which would mean paring back my stock funds to their target portfolio percentages. (Please, no scolding emails: I’ll probably get to it in the weeks ahead.) Why am I so sanguine? There are four reasons.
First, I’m globally diversified. It’s hard to get a good handle on stock market valuations right now because corporate earnings for the past 12 months have been so battered by the global pandemic’s economic slowdown. Still, suppose we compare Vanguard Total Stock Market ETF, which tracks the broad U.S. market, to Vanguard’s Total International Stock ETF. The stocks in the former are trading at 29.1 times trailing 12-month earnings, while the stocks in the latter are at 20.1. What about emerging markets? The shares held by Vanguard FTSE Emerging Markets ETF are at 18.3 times earnings.
Moreover, the U.S. stock fund has notched 13.8% a year over the past decade, for a cumulative gain of 264%, while its international counterpart has notched just 5.2% a year, for a 66% total gain. I’m not suggesting we naively assume that U.S. and overseas markets are destined to see a role reversal. Still, history suggests that no market or sector outperforms or underperforms forever—and that we should see some reversion to the mean.
Second, influenced by academic research, I have an overweight in value stocks and smaller companies. That brings us to another huge disparity in valuations, this time within the U.S. market. Let’s again look at three Vanguard funds. The firm’s S&P 500 Growth ETF holds large-cap growth stocks trading at 37.2 times earnings, its S&P 500 Value ETF owns large-cap value stocks that are at 23.4 times corporate profits and its Small-Cap Value ETF holds shares at 20.2 times earnings. Again, there’s been a large performance gap over the past decade, though it’s closer to five percentage points a year, rather than the almost nine-percentage-point annual gap for U.S. vs. foreign.
To be sure, the companies in the S&P Growth ETF have brighter prospects—at least from a business perspective. But will those brighter business prospects translate into better stock returns? They have over the past decade, but I suspect weaker performance lies ahead, given today’s heady valuations.
Third, I have plenty of cash to cover my costs in the years ahead. I’m still making enough to cover my living expenses, thanks mostly to my work for Creative Planning. But even if that went away, I have enough in short-term bond funds and cash investments to cover my living expenses for the next five years, which should be enough to ride out a market decline without being compelled to sell stocks.
Finally, as I argued last year, I don’t see any alternative to owning stocks. After factoring in taxes and inflation, cash investments and most bonds are priced to lose money. Readers have suggested more promising alternatives, such as buying rental real estate or becoming a partner in a small business. But I’m not inclined to take on the hassles and risk involved. The upshot: Despite the frothiness I see at the fringes of the financial markets, I’m sticking with stocks. That may prove to be the wrong choice in the short term, but I don’t see any long-run alternative.