Not Owning Stocks Today Is Risking Dollars To Make Pennies
A recent article posited that owning stocks today is “risking dollars to make pennies.” A review of historical data suggests this is alarmist and statistically unlikely; it also implies an overly narrow definition of risk. Stocks in general are expensive, but they still offer better return potential than bonds over the next decade, and there are plenty of individual stocks that offer low-risk returns. A recent article proclaimed owning stocks today is risking dollars to make pennies . For investors with a sufficiently long time horizon, I believe the truth is the opposite: NOT owning stocks today is risking dollars to make pennies. I’m not advocating being all-in on the S&P 500 or anything like that – I have plenty of cash reserves – but in line with Seeking Alpha’s “read, decide, invest” motto, I think it’s important for investors to understand both sides of the issue. I would recommend you read the linked article (written by Jesse Felder) prior to going any further. Let’s start from a high level: What does “risking dollars to make pennies” mean? Well, according to Jesse, it means stocks are so wildly overvalued that your potential return over the next ten years is miniscule, and your potential downside is massive. I posit this is: A) alarmist and statistically inaccurate; B) overly narrow in its definition of risk; and C) treats “stocks” as some monolithic entity (which devalues the excellent investment ideas posted every month here on Seeking Alpha). Starting with point A: What is the actual likelihood of stocks resulting in a significantly negative 10-year return? Here’s a link to a nice document providing this data from 1926 through 2013 in both tabular and graphical format. Summarily, there were only a very few rolling 10-year periods when investing in the S&P 500 would have resulted in losses in nominal terms. Specifically, you would have had to invest right before the Great Depression or in the late 1990s – two of the larger bubbles of all time. Even on an inflation-adjusted basis, there were not many periods when stocks had negative returns. Most of the time, stocks have had substantially positive 10-year returns, averaging 201.15% across all rolling ten-year periods during those 87 years. The two supporting arguments for the author’s assertion that the 10-year return on stocks will be less than the risk-free rate are: a graph of GDP versus market cap over time, and a graph of household equity ownership. The former is merely one data point that ignores substantial changes in the makeup of the economy. Relative to the past, today it is much more service- and knowledge-oriented – thus, there are higher returns on capital. This statistic also ignores changes in effective tax rates over time, which have benefited reported profitability (and consequently, valuation). As for the latter point of equity ownership, let’s discuss that. Point B: Paraphrasing the original article title, I believe NOT owning stocks today is risking dollars to make pennies. Paltry yields on fixed income mean traditional “your age in bonds” portfolios may no longer achieve the returns they used to, and this is likely one factor driving more investors into equities. The 10-year yield barely exceeds the Fed’s targeted inflation; while there are reasons to believe inflation may be on hold for now, the point remains that you will make no more than pennies by investing in bonds. Moreover, there is more than one definition of “risking dollars” – assuming you have a ten-year or greater time horizon and need to invest to fund long-term liabilities (kids’ college funds, retirement, etc.), then earning near-zero returns by investing exclusively in bonds is just as much of a risk as potential volatility from investing in stocks. Risk, in this context, means you won’t meet your financial goals – and if you don’t invest in any stocks, it’s very hard to see how you will generate sufficient returns with yields on fixed income where they are. Please note that I am not arguing stocks are cheap – in fact, I think most indexes are on the expensive side – I’m just saying that if I had to put all of my money in either stocks or bonds for the next ten years, it would be stocks without a question. Finally, point C: I think it’s unfair to treat “stocks” as a monolithic entity – as if you either own the S&P 500 (NYSEARCA: SPY ) or you do not, and there’s no other alternative. Even if you believe the market as a whole is overvalued, like I do, that doesn’t mean every single component of the market is overvalued. To the contrary, there are plenty of low-risk, high-quality companies with good management teams, conservative balance sheets, and solid future prospects that trade at reasonable multiples of cash flow or earnings. One such company which meets these criteria is Prosperity Bancshares (NYSE: PB ), which I’ve written about here . That is far from your only option, of course – but as long as you stick to those basic criteria, you will certainly be able to identify companies that will outperform 10-year Treasuries or corporate bonds. If you can’t find a single stock which meets these criteria, then you’re not spending enough time on Seeking Alpha! To conclude, there is a charming (if crude) saying about what part of your body opinions are like – the punchline is “they all stink” – and this aphorism applies especially to macro predictions, which almost always end up being wrong. Economists have predicted 12 of the last 2 recessions, etc. The future is obviously unpredictable, so we have to make logical decisions based on the information we have available. Despite the high valuation of most indices, stocks (whether individually or via ETFs or mutual funds) still seem to offer much better prospective returns over the next ten years than fixed income. As such, while it’s obviously the responsibility of every investor to determine their own risk tolerance and investment goals, it seems not owning any stocks is risking (future) dollars to make pennies.