July 2024
Here are some key takeaways from their conversation:
- Jeff highlights the importance of setting realistic expectations for stock returns, noting that the past decade’s 10-12% returns may not continue.
- Jeff discusses the benefits of investing in various asset classes beyond stocks and bonds, such as real estate and private lending. Diversification can help manage risk and volatility.
- Valuations matter when predicting future long-term returns. Historically, higher starting valuations have been associated with lower future returns.
- Jeff is cautiously optimistic about the market and advises careful consideration of valuations to manage risks effectively.
Watch previous episodes here:
Ep. 92 Advanced Estate Tax Planning Strategies
Ep. 91 Best Cybersecurity Practices to Guard Your Finances
Hello, everyone, and thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host Chris Galeski, joined by CEO of Morton Wealth, Jeff Sarti. Jeff, thanks for joining us.
Great to be here, Chris.
You know, there's a lot to talk about, especially this year with kind of what's going on in the market. We got elections, we got inflation, we've got crypto and gold going all over the place. But you know, today we're talking a little bit more detail about the role of stocks in a portfolio.
And some about valuations as well. And just the role of investing. Funny enough I was, over the weekend, my wife and I were going to Costco and we decided to go to a sandwich place before Costco because the girls were hungry. So I'm sitting in the sandwich place, my wife, my four-year-old, my 18-month-old, and sitting next to this table of this young couple that was in their early to mid-20s and I couldn't help but overhear them talking about investing.
So my ear kind of perked up and I heard the gentleman say to his girlfriend, he said, yeah, and just imagine if you put that amount every year into your Roth IRA and got these returns in just a simple index fund. Here's what your account would be worth now. And he showed her his phone and she was just like, wow, that's a lot of money.
And part of me was just elated that there was two, you know, two young couples, two young investments. That's a great thing about investing. But, you know, for him to set the expectation that, yes, you know, a simple index fund is 10 to 12% a year, the last ten, 12 years.
Yeah. And that's going to happen in the next ten years. I mean he's potentially setting her up for, you know, some frustration if valuations come down a little bit.
Yeah. No. Great point. Yeah. We all think it's our God-given right to generate call it 10% a year in stock returns. Because that's what most of the past has shown us. But as you mentioned it could be a little bit of a choppier ride from one decade to the next, without a doubt.
Right? I mean, even if you just started investing in a given year, just a normal fluctuation in a given year, you know, 10 to 15% in value. So, you know, I know most years the stock market is up, but if I invested, you know, $100 and it went down to 85, that's a lot different than what, you know, her friend was potentially telling her.
Yeah, we've been so spoiled outside of 2022. Each year, each year in the last call it 12 to 15 years. It's mainly been up. So that was really spoiled by those upward moving returns.
Yeah. But if you look back, so I agree with you. But if you look back to those years that stocks did really, really well in the last 15. Interest rates were zero. People that were investors or savers had nowhere else to go and invest because the majority of our industry just invest in stocks and bonds.
Yeah, we're far different. We have access to real estate and gold and other types of private lending. And so when interest rates are zero, it's going to force investors to kind of take on more risk and invest in more and more stocks. Yeah. And so I get frustrated with our industry- they say, oh this is the only way you should do it.
Right. And that's not accurate. There are a lot of different ways to help protect, grow and generate income for people. And what's the purpose of investing in general? Like if you think about why people should be invested.
I mean, just generally you have to take on some risk, right? Mainly to beat inflation. Inflation is the key driver of why you really have to put your dollars to work. Because if you just put your money under a mattress right, that $100 you wake up in five years, it's still $100, but the price of goods and services went up, you know, by x percent a year over that five years. And now all of a sudden you're underwater. And inflation now is top of mind. For the last couple of 15 years, we've really been in an environment where inflation has been fairly low. So that mindset hasn't really been a huge issue because it would... it's really easy to beat a 2% inflation rate. But now that inflation is higher and a little bit stickier, I mean, it's even more crucial that you have to take risks with your assets and invest in a variety of asset classes with the goal of outpacing inflation or the cost of living over time.
Yeah. I mean, inflation just erodes your purchasing power over time. And really what it does is yes, it's causing you to buy less goods and services, but it's stealing your time. Yeah. Because now as a saver or an investor, I have to take more time or more energy to be able to save that same amount needed to purchase that home or that car or those groceries.
And so, you know, people, if you value your time, people should be investing and trying to grow. So that way inflation doesn't hurt them over the long run. Yeah. Let's talk a little bit more about kind of the role that stocks play in the family of stocks.
One, from a long term point of view. And we're going to talk about valuations and our thoughts about stock returns going forward. But from a big picture point of view, stocks are a wonderful way to have exposure to global growth. When you think about beyond just real estate and the private lending and other investments, one wonderful way to get exposure to all industries around the globe, from financials to technology to consumer goods, you name it.
It's really through stocks. And it's a way, again, not just to get sector exposure but geographical exposure to across various international countries. So it's a wonderful way to get exposure to growth assets.
I mean, most of these companies are companies that we're spending our money, you know, at, you know, day in and day out weather, you know, not to promote any names. I'm not giving financial advice here to grow by any means. But you think of like the Costcos, the Targets, the Procter and Gamble, the Apples of the world.
I mean, we are spending the world is spending money at these places. And so it's nice to have exposure to those companies to help offset that growth. The industry in the talking head say stocks do this every single year. And you know historically it's around 10% a year. And so now all of a sudden people have that expectation right of hey stock should be up ten.
And we even see it from time to time when we have a year where stocks are flat, you know, some clients are like, hey, what's going on? Sure. so the industry likes to promote this as fact, when in reality if you look back is not.
That's a great point. So yes, from a long term point of view, if we're talking what's long term, it's a great question. So if you go back, let's say for the last hundred years, yes, stocks have average, let's say roughly around 10%, a real nice risk-adjusted return. But I think if you ask that question what is long term?
I think the most common answer we get is call it ten years. And actually I would agree that is a long time, right? But if you look over rolling ten-year periods, there are plenty of times over the last hundred years where stocks really underperformed and we're even call it flattish, performed, you know, flat definitely underperformed inflation over those ten years.
So I think when you're investing in stocks, you really even have to have a 15 or even 20 year mindset.
Yeah. You're kind of alluding to, you know, like the last decade of call it the late 90s, early 2000, there was a number of other cycles in. And so why do we have these periods where we've got tremendous growth in stocks, but then also stocks going sideways, both domestic, international.
At its core, the most powerful predictor of future long term returns. It's valuations. So valuations... it's a starting point.
So the price that you buy something.
A simple valuation is let's say a price to earnings ratio. You know that's a classic metric that most look at. So if a company produces a dollar of earnings if you pay $10 for that stock, that would be a ten price to earnings ratio. If you pay $20 for that same stock, that would be a 20 price to earnings ratio.
And what history shows, we all look at recessions and other economic indicators. The most important predictor of future returns is just simply valuations. If your starting point are cheap valuations. And we'll go over some historical examples, but let's say in 1982 is an example. Stocks were very cheap. The next two decades. Stocks did very well. It was mainly because stocks were just cheap.
As a starting point, you mentioned a lost decade of the late 2000, 1999. We hit peak valuations. We all know the dotcom bubble, dotcom bubble. So what happened the decade thereafter? Very poor returns as valuations came back to earth.
Yeah. And that's just a couple of examples in the U.S., you shouldn't even go to the UK and other, you know, other markets around the world. And there's definitely been periods of these these last decade. So some other examples, you know, so we've got like 1929, 1966 and 1999 where there were long stretches of time where the market was basically flat.
And that has to do with valuation.
Can we go over a couple of examples, because I just looked at this data and it was even alarming to me to some degree, the extent by which stocks underperform by quite a long period of time. So we all know the 1929 stock bubble where valuations reached pretty high extremes. The stock market did not come back to even until 1943.
So basically almost 15 years just to break even. Obviously then you're losing out to inflation over that time frame as well. You mentioned 1966 again reached a high level of valuations in the mid to late 60s. Stocks didn't break even there. I think it was basically 1974 1975. So about an 8 or 9 year period. But the actual story's worse than that because remember, that was a very high inflationary time.
So to match inflation it took to 1982. So if you look from 1990, excuse me. Yeah, 1966 to 1982, inflation averaged 6% over that 16 year period. That's what stocks average. So you actually it took 16 years to break even with inflation. And then the last one which we quickly mentioned was 1999. So the last decade of the 2000 since basically was ten years where stocks were flat after the 1999 bubble.
It's so fascinating. I mean, most clients say, hey, I don't want to lose money because I don't think that I have the time now to make up for it. And so that's why preservation of capital is so important. We also need to generate income. But when you talk about valuations let's go with the price to earnings ratio.
What's the price to earnings ratio right now nased on various metrics?Whether you're looking at previous 12 months earnings or forward earnings, that number could differ a little bit. But call it were in the mid 20 range. So sort of in the 23 to 25 price to earnings ratio. And for context for the audience that is expensive. That's not mildly expensive. It really is borderline very expensive.
The only real time that exceeded that from a valuation point of view was the late 90s bubble. We talk about other extremes, 1929, 1966. Those were more in the high teens PE ratios, and we've exceeded those in the current environment.
I don't remember. I know that, you know, 15 years ago when I started this industry as a Morgan Stanley, and I feel like some other advisors were talking about, you know, PE ratios tend to be around like the 12 to 15 range, call it that. So let's just pick a number. Let's say 14. Yeah. the 1929 when I took, you know, 14 years for the market to come back to even. The PE ratio was 18 in 1929, and that came all the way down to eight.
So that's a difference between like, hey, I want to be a seller at 18 and a buyer at eight. Yeah. Similar story in 1966 where the PE ratio was around 18, 19 and it came down to seven.
Yeah, early 80s when no one wanted to touch stocks. Right. The PE ratio was in the 7 to 8 range. Right. Incredibly attractive.
Mortgage rates were I don't know what, 11, 12.
Then in the dotcom bubble, the PE ratio you mentioned peaked at the low 30s. 33 and then it dropped down to call it the low teens. You know, in the decade in the 2009 2010 timeframe, a decade later.
Yeah, yeah, I'm glad that you mentioned how important valuations are. It's just like anything, whether in stocks or real estate or art, the price of which you're going to get in the future and the growth or the performance greatly is determined by the amount that you originally paid for it. And there's times where, you know, there's a lot of money flooding to one asset or another.
We're not calling for a crash, but just trying to educate the audience on the importance of valuations and why we're cautious with regards to stocks in the current environment.
Yeah, to your point. Listen again, as the audience knows, we have no crystal ball nor we did attempting to try to time the market. That being said history matters. And as we mentioned the beginning of this discussion, nothing matters more to future returns and starting valuations. So with that lens of history that are best guess is that stock returns might be more disappointing for the decade to come as compared to the decade that it's just happened.
So again, we of course own stocks for a variety of reasons. That being said, this is one of the main reasons why we're so passionate about being in other asset classes where we think we can generate stock like returns, call it that high single digit, low double digit return without taking on these risks, namely valuation risks that we speak, that we've been speaking about.
Yeah, I feel like the old guy in the room wanted to talk about how good bonds are or the private lending or the loans are, to those, you know, but really, because interest rates have come up from zero, there are some very attractive returns that we are finding, whether it's in the fixed income private credit space.
Yeah. And so we are able to generate sort of longer term stock like returns from that without taking nearly as much risk or volatility. Yeah. Jeff, thank you so much for joining us. And we'll see how this plays out. But please pay attention, value options matter. I'm excited about some of the things that we're seeing in the market in the growth.
But just be cautious.
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