written by Chad Freeman:
Ever feel like investing in the stock market is a gamble?
If so, you’re not alone. As opposed to investing, most stock market players are actually speculating. There is much risk involved, and most of the time the bet fails. For many years the stock market has been like a rocket ship, shooting higher and higher, and many gamblers have made a great deal of money. There will be an end to this. Most people tend to forget past events and focus on the present and forget how drastically things can change.
Many speculators will lose fortunes when market cycles occur. They hold on to lousy stocks that they don’t understand, hoping that market conditions will improve later on. A speculator’s pain from loss eventually becomes too great, so they sell the stock at a great loss, usually near the bottom of the market. This is partly explained by a phenomenon called “divestiture aversion”. It happens when we place a higher value on something simply because we own it; therefore, people place a higher value on their stock simply because they own it.
The financial history of Wall Street is littered with examples of money managers who failed to make money in the long run. Successful long term speculation is so difficult that fewer than 10% of professional traders succeed in the long run.
Most people do not possess the skills needed to make successful stock market investments. The process of determining the intrinsic value of a company and then of an individual stock before making an investment involves extensive education, countless hours of work, knowledge of accounting, business, economics, and analysis of a companies’ qualitative and quantitative attributes.
Stocks are more expensive aka riskier than ever before.
A great indicator of the price of the stock market today would be the total market cap to total GDP ratio, popularized and described by Warren Buffett as the single best measure for the overall stock market valuation at a given time. As you can see from the chart below, this indicator is at an extreme high, it is currently at its highest level in history and over 200% of total GDP.
Also from GuruFocus.com:
“The Stock Market is Significantly Overvalued according to Buffett Indicator. Based on the historical ratio of total market cap over GDP (currently at 203.5%), it is likely to return -3.3% a year from this level of valuation, including dividends.
What returns can we expect from the stock market?
As of today, the Total Market Index is at $ 44894 billion, which is about 203.5% of the last reported GDP. The US stock market is positioned for an average annualized return of -3.3%, estimated from the historical valuations of the stock market. This includes the returns from the dividends, currently yielding at 1.3%.”
S&P 500’s price to earnings (PE) ratio stands at 45 today.
This represents an expected return of only 2.2%, well under the current inflation rate (nearly 4% according to the Federal Reserve). In reality, inflation is higher because the US Federal Reserve uses an index based on personal consumption expenditures (PCE), which does not account for financial assets or real estate.
John Hussman, a hedge fund manager and economist, uses the PE ratio to estimate future returns. This is what he said in an interview with the Financial News Herald: (read the full article financialnewsherald.com )
“Stock prices haven’t just priced in a recovery. They’re already beyond where they were before the pandemic,”
“Indeed, we currently estimate that the average annual nominal total return of the S&P 500 is likely to lag the returns of Treasury bonds, by fully -4.6% during the coming 12-year period. So much for the notion of an ‘equity risk premium.”
“You’ll notice that extreme valuations aren’t always immediately associated with drawdowns.”
“Unfortunately, the drawdowns generally arrive with a vengeance. At present, we expect the current cycle to be completed by a market loss on the order of 65-70%.”
“Yes, I know. A drawdown of 65-70% sounds insane and utterly preposterous, but the revulsion to that idea is largely due to pervasive speculative psychology, not historical evidence, cash flows, or fundamentals.”
How about bonds and fixed income investments?
Inflation today is a serious concern. The amount of money in circulation and the speed at which it is circulated are major contributing factors of inflation. As the economy has resumed, consumer spending has spiked to levels that exceeded those pre-pandemic. Money supply in today’s economy is very large due to government stimulus and spending in response to the pandemic. Federal officials are discussing inflation control measures as early as next year. CNBC reports, “Inflation climbs higher than expected in June as price index rises 5.4%” (cnbc.com), some economists argue true inflation is already over 10%.
What does all this have to do with bonds? During times of high inflation, bonds perform poorly since depreciating currency values erode fixed interest payments. Bond yields move inversely to interest rates. What is the primary tool the Fed uses to combat inflation? Control over interest rates. Interest rates today are at 800 year lows, and they cannot continue to fall further unless they become negative, which would in turn lead to more inflation. Since the 1980s, the bond market has enjoyed a low interest, high yield bull market. So, what lies ahead for bonds? Most likely lower yields due to higher interest rates. When interest rates rise, it will be difficult for bonds to continue to perform well, pay interest, and return capital gains.
In addition, the 10-year U.S. Treasury note and similar bonds are offering zero or negative yields. Today, the 10-year Treasury note yields 1.26%. It has only been this low one other time since the late 1800’s during the pandemic in 2020. If inflation is taken into account, the yield on these notes actually becomes negative, meaning the investment actually loses value.
The Contrast
Our business is investing. We do not gamble with money. We operate tangible assets in the form of high yield income properties that are able to adjust for inflation. Through mobile home parks, we offer quality low income housing communities. We are fortunate to benefit from a sector that enjoys stable conditions, tremendous demand, low competition, a tightly restricted supply, government-supported entry barriers, and underpriced rent rates. Our business does well in both good and bad economic times, but especially well during recessionary periods. Furthermore, it has been deemed “essential,” meaning that it cannot be shut down during a pandemic.
If you’re looking for a way to gamble, buy stocks! Or maybe you can go to Vegas, it’s probably a lot more fun. If you want to invest your hard earned money in a simple, proven business then get ready! Click on the “start investing today” link.