Last Saturday night I attended a class reunion.
There were the usual questions going around…Married? Children? Grandchildren? Career? Still working?
However, one question that soon to be or already retired boomers have on their mind is where do you invest your money these days?
When we left school in 1976, 90-day bills were paying 9%. You could buy a house within 10kms of Brisbane city centre for under $30k. And the All Ords Index was around 300 points.
Not that any of this mattered back then. We had no money. Life was ahead of us.
Fast forward 44 years and the data does matter.
Where do you put your money for a decent return in retirement?
Since 1980, my former classmates, myself and millions of other boomers have been conditioned by one major trend.
Shares and property go up — both asset classes rising over 20-fold in value. And interest rates go down…from high teens to almost zero.
But that’s the past, what about the future?
Based on life expectancy tables, we (the Class of 76) have more years behind us then years ahead.
However, the years ahead are going to be the most challenging the world has encountered in our adult lives.
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Investing in cash and term deposits is the least worst option
My contribution to the discussion was ‘the least worst option is investing in cash and term deposits’.
The predictable response was ‘but you get nothing in the bank’.
‘It’s not about return ON capital but return OF capital’ was my equally predictable reply.
The overwhelming need for retired boomers is…yield.
‘We need $X to cover our living expenses.’
However, the search for yield is a twin-edged sword. It comes with the potential for capital gain or loss.
The other forgotten variable in yield is rents and dividends can be cut…as we’ve seen recently.
Nothing is ever one-dimensional. Discussing the nuances of investing in a social gathering is way too hard.
When the topic shifted to the plight of the woeful Brisbane Broncos, the challenges of a yield-starved retirement didn’t seem so bad.
However, if it had been the right time and right place, this is what we could have talked about in a little more depth.
There are moments in markets — precious metals, shares, cryptos, property — when speculation takes hold. Continued manic buying reinforces the positive feedback loop.
The duration and extent of a speculative run is only ever known with hindsight.
But more often than not, it’s usually longer and higher than most people expect.
What we also know, is these periods of disconnect ALWAYS end…ALWAYS.
And the reason for that is simple…valuations matter.
In 1987 (before the famous crash), Kerry Packer sold his beloved Nine Network to Alan Bond for $1 billion. Why? Because he knew what the true value of the network really was.
Three years later, in 1990, Packer bought the network back for $200 million.
If value is rendered obsolete, then there would be no need for long-standing valuation metrics to ever again be relevant.
The very notion of which is complete nonsense.
As the old market saying goes ‘valuations don’t matter until they do’.
Here’s a sample of what those old-fashioned models are saying about future prospects of our new-age market.
‘The enterprise value (EV) to the earnings before interest, tax, depreciation, and amortization (EBITDA) ratio.
‘Typically, EV/EBITDA values below 10 are seen as healthy.’
The following chart dating back to 1990 uses the S&P 500 EV/EBITDA to forecast future 10-year returns (grey line) and then overlays the actual 10-year return (red line) from the US market.
Source: CMG Wealth
The model has an 89.2% correlation between the forecast rate and actual return.
The current expected return for the next 10-years is…MINUS 0.18% per annum…not all that different to what was being forecast at the height of the dotcom boom.
Shiller PE Ratio
‘Shiller P/E…is a valuation measure usually applied to the US S&P 500 equity market. It is defined as price divided by the average of ten years of earnings (moving average), adjusted for inflation. As such, it is principally used to assess likely future returns from equities over timescales of 10 to 20 years, with higher than average CAPE values implying lower than average long-term annual average returns.’
Currently the Shiller PE Ratio (at 30.4 times) is sitting in rarefied territory…alongside market highs in 1929, 2000 and pre-COVID 2020.
The All Time Historical Average is 17.1-times.
Where to from here?
Source: Guru Focus
The following table looks at five potential scenarios from really lucky to really unlucky.
Source: Guru Focus
A simple ‘reversion to the mean’ results in the S&P 500 return 3% per annum over the next eight years.
But if the worst economic downturn since the Great Depression turns out to be a little or a lot unlucky, then it gets a little or a lot ugly.
We are looking at anywhere between MINUS 0.5% to MINUS 5.2% per annum over the next eight years.
What about BALANCED FUNDS?
Hussman Strategic Advisors produce the following model on the forecast returns (blue line) of the typical 60/40 balance fund mix over a 12-year period.
The actual 12-year return (red line) has a 90% correlation — dating back to 1928 — with the projected return.
Source: Hussman Strategic Advisors
The current forecast 12-year return of 0% per annum is on par with that of 1929 — just before the crash.
Anyone who thinks term deposit rates are low need to acquaint themselves with long-term market valuation models.
Personally, I would rather sit in term deposits earning 1% for the next year or two. Waiting for the forecast (long-term) returns in these proven valuation models to move back towards the double-digit range.
The way I see it, term deposits are a temporary pain. Whereas the capital losses (yet to be fully incurred) are going to be far more permanent.
With the Class of 76 having an average life expectancy of 24 years, do you really want to spend half that time earning ZERO percent on your capital?
Each year you’ll be dipping more heavily into a diminishing capital pool to fund an increasingly more austere retirement.
I wonder what conversations we’ll be having at future reunions?
How’d you fare in the crash of 20/21? Are you back at work? What do you think of those reverse mortgages?
Editor, The Rum Rebellion