Juggling Dynamite

As home prices have gone skyward, it’s increasingly less typical for people to pay off their mortgages before retiring and the proportion of non-mortgage debt outstanding has ballooned.  Research confirms that debt can have a negative effect on health, especially as we age (no surprise).

Elevated health problems and medical expenses join lost productivity to compound the costs of debt-induced asset bubbles and systemic fragility.  See In Older Americans, Rising Debt may Adversely Affect Health:

Researchers at the Urban Institute, by analyzing broad national data over nearly 20 years, have reported that indebted older adults fare measurably worse on a range of health measures: fair or poor self-rated health, depression, inability to work, impaired ability to handle everyday activities like bathing and dressing.

Those in debt were also more likely to ever have had two or more doctor-diagnosed illnesses like hypertension, diabetes, cancer, heart and lung disease, heart attacks and strokes.

“There seems a clear causal link between certain types of debts, especially at higher amounts, and negative health outcomes, both physical and mental,” said Stipica Mudrazija, a senior research associate at the institute.

The investment marketing world urges that every day is a valuable buying opportunity and fear of missing out is a formidable bait.

This is especially true since many participants have never lived through a typical bear market (where the average S&P 500 decline was 29% over 12 months if the economy was not in recession and 42% over 16 months when it was.)  Others have seen bear markets but have blocked out the experience (willful blindness) or chalked it up to one-off-bad-luck, unlikely to repeat–aka, this time is different.

After a decade of ‘easy money’ policies aimed at inflating asset prices at all costs, mean reversion is a much-needed value-restoration force. Many securities have made some promising downside progress, year to date, to be sure.

However, in terms of the eight indicators proven to have the best predictive power of forward-10-year real equity returns–we aren’t at enticing investment value yet. Mark Hulbert summarizes the data well in WSJ: Are Stocks Undervalued Yet?:

On balance, these eight indicators at the mid-May low stood at more than twice the average valuation of the bear-market bottoms seen in the past 50 years. And, seen in comparison with all monthly readings of the past 50 years, the average of the eight measurements was in the 88th percentile.

Mark’s summary table below shows the eight latest metrics (in blue) at the top end of the monthly distributions over the past 50 years.

While the S&P 500 trailing 12 months’ earnings per share (first line above) has come down in 2022, as of mid-May, it remained 16% above its average level at the lows of the past 50 years.

Moreover, this price-to-earnings (PE) reading is with backward-looking 12-month corporate earnings still near record highs. As earnings inevitably come off the boil, the dropping denominator will elevate this ratio until the numerator (price) tumbles significantly further–as has happened at every bear market bottom in history.

One of the most telling value indicators of the group is the average investor’s equity allocation as a percentage of their financial assets—equities, debt and cash (second blue bar above). The latest Fed data available was at the end of 2021, when equity allocations were at the 99th percentile of all readings over the past 50 years.

Infamously, the masses hold the most risk near market tops (and the least cash), so they look smartest just before they lose in bear markets and have the least ability to invest near bottoms (when prospects become the best of the decade). Doing the opposite of this behaviour isn’t easy, but it’s recommended.

History assures that financial stability and meaningful investment opportunity is earned through math-based analysis, patience and personal discipline. The lack of these is why many win for a while but end up worse.

We will know we are near a valuable cycle low when the majority is liquidating equities and thinks buying is a bad idea; not there yet.

Useful insight in this discussion on consumer spending, ETF/mutual fund liquidity risks, common allocation mistakes in housing and investment portfolios, and the value-add lacking in mainstream financial advisory services. Worth listening.

Ted Oakley interviews Danielle DiMartino Booth about her outlook on global economics, inflation, U.S. housing, Federal Reserve policy, and how it will affect investors. Ted Oakley interviews Danielle DiMartino Booth about her outlook on global economics, inflation, U.S. housing, Federal Reserve policy, and how it will affect investors. Here is a direct video link.

The chart below since 2005 (courtesy of Isabelnet.com) shows that the value of equities has been dropping for the last six months, but their weight in broker-advised accounts remains near all-time highs at 62% of assets under management. Sentiment may be bearish, but the broker/advisory crowd still keeps client funds in the equity fire (where fees are most lucrative for the firms). So far, clients are still holding the exploding dynamite; this too shall pass. Capitulation selling is yet to come.