Last time, we looked at how the Fear Of Missing Out (FOMO) might be contributing to markets being expensive. That’s not the only plausible behavioural explanation for what’s going on in capital markets these days. There’s another obvious candidate to explain sky-high valuations: the utter lack of a viable investment alternative. The acronym that pundits use is TINA: There Is NO Alternative.
As I type this, the ten-year yield on both Canadian and American bonds is less than 1%. Invest $100 today and you’ll have less than $101 to show for your trouble this time next year. The problem is simple: people still need to save for their retirement. They still need to put their kids through school. The historical needs for financial advice and financial planning have not gone away and the laws of product investment management have not been repealed. We all need to save and invest – but if bonds pay (quite literally) next to nothing, what are we to do?
As we have all lived through the greatest bond bull market in history, the easy money has been made and all that’s left are the hard decisions about the path forward. Part of the problem, as mentioned in another blog (see Under Promise and Over Deliver from September 15), is that we’ve all grown accustomed to historical returns that are highly unlikely to be seen again. It is far more likely that, even though inflation is likely to remain benign (the silver lining), real returns will be in keeping with historical averages at best and, more likely, lower than historical averages due to high valuations going forward. A traditional 60/40 investor (60% stocks; 40% bonds) can feel reasonably secure when stocks are returning 9% and bonds 4%, but when that 5% spread is shrunk with a lower baseline, people will naturally re-calculate their thinking.
Most people construct portfolios that mirror their risk tolerance. A historical rerun on a 60/40 portfolio is about 7% (.6 x 9% + .4 x 4% = 7%), but these days, might be closer to 4%. Even if you decide to make other accommodations, a 7% expected long term return is literally unattainable when the best-performing asset class (equities) only returns 6%. The current mindset is that bonds are for shmucks and ‘cash is trash’. I would caution strongly against reverse-engineering your asset mix in order to try to shoehorn your retirement plans into generating the returns you’ve grown accustomed to. Those days are over. The sooner you deal with it, the better.