Current Market Conditions And Asset Allocation

Hey, The Investor’s Podcast Network Community!

With the stock market at an all-time high and returning 24.5% so far this year, I wanted to bring up a question that I’ve been asked multiple times over the years: Should my portfolio ever be 100% allocated in the stock market?

Let’s look away from the valuation of the stock for a second and focus on the concept of asset allocation first.

It might surprise you, but for many of our younger listeners of The Investor’s Podcast Network, I don’t think being 100% invested in the stock market is a bad idea at all. Again, I’m looking away from the current valuation, but I promise to get back to that in a bit.

You often hear that you can’t use historical performance as an indicator of the future. Surely, there is some truth to that. I don’t have an idea whether the stock returns for the 21st century will be similar to the stock returns of the 20th century, which was 10.63% annually (7.30% adjusted for inflation). However, I’m confident that stocks in the 21st century will yield a considerable positive return.

How do I know? Well, one reason is that when I walk into a McDonald’s or a Starbucks, I see an efficient business that can be run by teenagers with a minimum of training.

Huh?!

Okay, please allow me to elaborate. McDonald’s and Starbucks have a market cap of $150B and $100B respectively because every year, they generate a sizable profit back to their shareholders. The efficient systems that surround their respective businesses exemplify the entire idea of having a business in the first place. They allocate resources more efficiently than anyone on the planet could do themselves. Every quarter, the shareholders of McDonald’s and Starbucks collect a juicy dividend while the rest of the free cash flow is either used for buying back shares or redeployed into assets to generate even more profit for the owners.

Add to it that technology creates a win-win for both corporations and the consumer. One example is how Starbucks allows the customers to use their phones for everything — from more efficient payment processes to locating the nearest Starbucks store. That’s just two of the several arguments why stocks are bound to go up in value in the long run.

In other words, if we’re looking away from the specific example of McDonald’s and Starbucks, and think of corporations in general, can we imagine a world where the very nature of having a corporation won’t create efficiency gains? Can we imagine a world where technology stops improving in the long run? If the answer to both questions is no, then there is no good reason to think that a portfolio with 100% stocks won’t do well over time.

So let’s go back to the discussion about valuation. Is the stock market overvalued right now? Very likely. But the stock market is overvalued because the expected earnings you get doesn’t justify the price you pay. It’s not overvalued because it’s near an all-time high. The stock market was also overvalued in 1929 when Dow Jones traded 305 on the first day of the crash (Dow Jones is trading at 28,036 at the time of writing).

As previously discussed here, corporations have become more and more efficient and can be expected to continue doing so, sharing more of an ever-growing economy (GDP worldwide has grown 51 out of the last 55 years). Stocks have to go up in value and ultimately continue to make new all-time highs. Said a little simpler: technology advancements enhance productivity, which leads to a higher GDP, which in turn results in higher stock prices.

Does that mean you should be 100% invested right now? That is a very different discussion. Optimally, the investors should follow all asset classes and allocate accordingly to where they can find the most value. There are, however, built-in problems with that. First of all, it’s a lot harder than it sounds even if you do it for a living. And since most of us have a full-time job, I only suggest this strategy to a very few of our listeners.

For most of our listeners, I suggest you try to fully understand the reasons why the stock market moves as it does in the short term (can act highly irrational) and in the long term (is bound to go up in value). Once you understand that and the driver behind it, there is nothing wrong with having the bulk of your investable portfolio in a cheap ETF tracking the world stock market.

Of course, you shouldn’t go out and sell your house or put your emergency funds into stocks. But if you do have a long time horizon and would like to invest in a proven method using a minimum of time, it’s hard to find a better asset class than stocks. As you approach a time when you need the money, you also need to have a different focus than the highest expected returns. You should consider limiting your exposure to the stock market, thereby mitigating the downside of negative volatility.

But what if you plan to invest for decades to come and you think that the overall stock market is too expensive? And what if you don’t have the time or the skills to pick individual stocks and invest in alternative asset classes?

If that is your perspective, I wouldn’t recommend you to be fully invested. Rather, consider if you should hold cash outside of the market and wait for a correction of the price. With the capital that you do want to invest, with the US being tied with New Zealand as the third most expensive stock market in the world with an expected return of 3.4% (only trailing Ireland with 1.8% and Denmark with 3.1%), I suggest you investigate many of the great ETFs out there tracking international stocks. Emerging Europe, for instance, is priced at a 10% return and emerging markets overall is close to 7%.

To help you out with this, I’ve created a free Asset Allocation Video Course, which thoroughly discusses the topic I’ve outlined in this newsletter.

Also, here is the link to all of our stock analyses. Just like the Asset Allocation Video Course, it is 100% free.
Your Friend,

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P.S. I’ll be hosting several free TIP networking events over the next months starting December 4th in Brussels, Belgium. Please reply to this email if you’re interested in attending that meeting, or if you would like to meet up with me and the TIP community in Los Angeles, California or Cleveland, Ohio.

For our free main event at the Berkshire Hathaway Annual Shareholders Meeting, which happens on the first weekend of May 2020, please check out this page or sign-up directly by sending an email to contact@theinvestorspodcast.com.

P.P.S. Since we launched The Investor’s Podcast Network, I’ve repeatedly been asked what plans Preston and I have for the time to come for our company. I don’t want to bore you with all the details in this newsletter, but if you’re curious, I’ve elaborated on the question here.