Stocks and Bonds: Value is Relative, not Absolute

In times like these, it’s really important to remind yourself to be calm and objective. Trump’s victory caused a sharp initial sell-off, but it shouldn’t lead to a nasty bear market or a credit crisis.

Presidents don’t cause bear markets.

So let’s take a step back from the election noise and think calmly…

In his classic book, The Truth of the Stock Tape, the famous trader WD Gann wrote that you should be bullish in a bull market and bearish in a bear market.

I’ve made this point before, and I’ll make it again. In fact, I should probably make it every week, to remind you that there isn’t much room for personal opinion when it comes to investing. You need to ‘go with the flow’.

So, should we be bullish or bearish?

While I have made the point over the past few months that we could be on the verge of a short term panic or correction (which looks likely on Trump’s win), I have also stated that I don’t see another credit crisis or major bear market unfolding.

I know this is a fear that many people have. But it is a fear largely based on what has happened in the past. That’s not to say the world is without problems. It has many.

But that doesn’t mean we get a big crash.

It does mean we’ll have panics and corrections that scare many people into thinking ‘this is it’. And it does mean returns probably won’t be as good from here as they have been in other bull markets. In fact, the major share price indices could move sideways (within large trading ranges) for prolonged periods of time.

But don’t let that stop you from seeking out opportunities that will deliver a better return on your capital than sitting in cash.

Consider this bullish argument that I made at our recent conference. By the way, I wasn’t arguing a bullish case, it was just one piece of evidence I used to show that the bulls can have just as convincing arguments as the bears.

Anyway, the current yield on US 10 year bonds is around 1.85%. That equates to a price to earnings (P/E) multiple of around 54.

The S&P 500 index trades on a P/E multiple (using forward earnings estimates) of 17.8.

That’s a significant difference. It tells you that relative to bonds, stocks are very cheap.

Big fund managers who run billions of dollars value the stock market relative to bonds, not absolutely.

Unless bond yields move into the 4% range (which would bring the P/E down to around 25 times) it’s hard to make the argument that stocks are wildly overvalued.

In a Trump presidency, if earnings falter or the US goes into recession, then yes, stock prices will fall. But so will bond yields, and the relative value argument will strengthen.

Can you see how this works?

Viewed through the lens of a multibillion dollar fund manager, it’s difficult to make the case that the market (in general) is overvalued. It’s certainly not overvalued in the way it was back in 1999, or 2006 for that matter.

Investment success is all in the mind

I said earlier that your objective in these turbulent times is to be calm and to ‘go with the flow’.

But that’s very hard to do when you see your portfolio suffering from big swings and you overthink a situation.

For example, if you’re bearish and think the market is built on a house of cards, you might think this Trump sell-off (if it continues) is the start of something big.

But that’s just your perception.

I’ve learned over the past few years that perceptions borne out of deep-seated biases are dangerous for your portfolio, and very hard to get rid of.

The real battle to achieve better investment returns lies not with trying to understand how the economy or markets work. It lies in understanding how YOU work.

I’ll write in greater detail on this in an upcoming issue of my premium newsletter, Crisis & Opportunity. But, briefly, I think a focus on the psychological aspect of investing — and a willingness to improve in this area — will reap huge long term rewards, if you’re serious about investing and managing your portfolio for years to come.

Look, most people aren’t interested in being introspective. And if you’re relatively new to investing, you might be wondering what I’m going on about.

But if you’ve had some experience in the markets, you probably know (even if you haven’t admitted it to yourself) that the biggest impediment to improving your returns is you.

Maybe you’re too quick to take profits and too reticent to take losses. This is not unusual. Nearly everyone suffers from this at some point. These self-defeating decisions are driven by hope and fear.

As my old mate Seneca (the Roman stoic philosopher) wrote in his book, Letters from a Stoic, when quoting one of his fellow writers, ‘“Cease to hope, and you will cease to fear”’.

That is, you can overcome these impulses with a bit of effort and your returns will improve.

Cheers,

Greg Canavan,
Editor, Crisis & Opportunity

Editor’s note: The above article is an edited extract from Crisis & Opportunity.

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Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here.

Official websites and financial e-letters Greg writes for:


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