It’s been good to be a stock market investor since 2009. Orgasmically good, actually. OH PISS OFF DICTIONARY THAT’S TOTALLY A WORD.
According to this fancy calculator, the ETFs that track the S&P 500, NASDAQ Composite, and TSX Composite Indexes are up 17.7%, 22.1%, and 11.0% annualized since a random date in March, 2009, respectively. Even Canada, which has suffered from pretty much every commodity crapping the bed (including, most famously, oil), has still done pretty well.
The funny thing about all of this is people hated stocks back in 2009 and 2010. Everybody warned returns going forward would suck and suck hard. Personal finance bloggers dialed down return expectations of 10% annually going forward to “more realistic” expectations of 5-6%. Naturally, stock markets did very well right after these predictions came out because if there’s one thing humans love, it’s recency bias.
Now that we’ve had basically seven years of uninterrupted bull markets, investors have the exact opposite expectations. We expect great returns to continue going forward, justified by things like how low interest rates are the new normal and how all the baby boomers looking for yield in their retirement. If they can’t earn enough to live on GICs or bonds, it’s only natural boomers will gravitate to dividend paying stocks and somehow screw over millennials.
Go ahead, millennials. Complain about it. If you’re loud enough, maybe your boomer parents will hear you from their basement.
These investors are wrong, of course. We’re not in some sort of new normal where P/E ratios will shoot up to 100x, even if Warren Buffett kinda suggested it that one time. The same thing will happen as has happened before. When valuations get too high, something happens that brings them closer to earth.
But what, Nelson?
I don’t know. Nobody knows. Sure, there are probably a few portfolio managers who are positioning themselves accordingly and who’ll look really smart when whatever it is happens, but as of today that’s just a guess.
What I can tell you is we’re almost guaranteed to have low returns going forward.
Why low returns?
It’s really quite simple. Stocks are expensive, and even though more companies than ever are starting to focus on paying dividends, it won’t be enough. Stocks will return to more reasonable valuations. The only question is whether it’ll happen quickly or if it’ll be a long drawn-out process that takes forever, sort of like the newest Melissa McCarthy movie.
Things look particularly bleak for U.S. investors. American stock markets are the most expensive in the world when it comes to CAPE (cyclically adjusted P/E) ratios. Large-caps in the U.S. are trading at a CAPE ratio of 26. Small-caps are even more expensive, with a CAPE ratio of 47. Canada is a little more reasonable, but it still has a CAPE of 18.
Based on CAPE ratios, here’s a table of expected returns going forward, courtesy of Research Affiliates.
As you can see, it doesn’t look pretty over the next decade for U.S. stocks, whether they’re small or large-cap. Things look a little better for Canada, but our expected returns are still under 6% annually, That’s not very exciting.
So what can you do about this? I have three suggestions. I’ll rank them in order of what I find least to most exciting.
Buy cheap domestic stocks
I’ve never really found the overall level of the stock market to be that big of a deterrence when it came to investing. I can still find cheap stocks even if indexes are flirting with record highs.
Today is no exception. There’s plenty of value in Canada’s small and micro-cap space. I think many of our REITs (especially ones with a lot of Alberta exposure) are undervalued. And the U.S. will always have cheap stocks.
But some people don’t want to pick individual stocks. They have neither the aptitude or the patience to do so. And even if we load up on cheap stocks, they’ll still likely get hurt if the market goes does. It is the nature of market crashes.
Which brings me to choice number 2.
Pay down debt
After recently buying a house, I now have a mortgage at 2.7%.
I haven’t really been sweating this debt, but it does weigh pretty heavily on my wife. So we decided to make paying down the mortgage a priority over the next few years with a goal of getting rid of our debt by January 1st, 2019. I did negotiate an out clause on this deal if stocks do crater a whole bunch and valuations become attractive, but as of right now I’d rather take the guaranteed 2.7% return from paying off debt.
If you have higher interest debt, I’d say it’s pretty much a no-brainer to pay that off rather than investing in stocks.
Maybe I’ll continue to do updates on the whole paying down the mortgage thing. Or maybe not. FINANCIAL UPROAR, KEEPING YOU ON YOUR TOES SINCE 1971.
Invest in cheaper equities
So you don’t have any other pressing needs for the cash and want to keep putting money to work in these expensive markets. What’s a fella (or lady) to do?
The solution is simple. Invest in markets with decent CAPE ratios.
The following countries are all expected to return better than 7% over the next decade:
- South Korea
Some of these countries are incredibly cheap. Russia has a CAPE ratio of 5, which means the fine folks at Research Affiliates believe it’ll return 14.4% annually for the next decade. Poland has a CAPE ratio of 8, which is an expected return of 11.9%. Turkey’s expected return on its 9 CAPE ratio is 9.6%. Even those greasy Italians are expected to deliver returns of 10.7%.
If you’re feeling especially frisky, I’m sure there are incredibly cheap stocks in each country you could buy to really goose returns. Or you could just take the lazy way out and buy an ETF. In my TFSA I have a position in RSX, an ETF that tracks the biggest companies in Russia. It has 32 holdings and a net expense ratio of 0.67%, which is a little high, but I liked it as a play on Russia and a play on energy. I’ve done well on it so far, and I intend to hold it for a while longer.
Other ETFs exist for these other countries, it’s only a matter of googling. You can do that, right? Just substitute “Pornhub” for “Turkey ETF”.