Morgan Housel is one of my favorite journalists right now. His recent piece If Other Industries Were Like Wall Street had me smiling (especially the gardening reference). He had a recent piece in the Journal The Market Is Your Friend. Really: One Millennial’s Advice to Peers though that I disagree with a bit. (Being born in 1977 I think I qualify for Gen X?). The article mentioned “Last year, a Wells Fargo survey showed 52% of Millennials are “not very confident” or “not confident at all” in the stock market.” Is that because Millenials are slacker morons? Or are they actually justified in their distrust?
The article mentions the benefit of time to starting early as an investor, as well as the fact that the market has returned about 6.8% real per year since 1871 as a reason investors should stay the course with stocks (since 1900 the number is 5.8% and worldwide closer to 5%).
But here’s the problem – it greatly matters what you pay when you start. Examining each decade in a similar fashion as the article back to 1900, and holding stocks for 12 years, we find that:
– Real returns ranged from -2.5% per year if you started in 1930 to 16% per year if you started in 1950. That is a wide spread of potential outcomes…
– Roughly a THIRD of all holding periods of 12 years per decade resulted in a loss!
– Starting valuations ranged from a Shiller CAPE ratio of 6 (1920) to 44 (1999).
– If you grouped the 11 decades into thirds, and averaged the best returning four decades and the worst four you have:
BEST FOUR DECADES
10.42% annualized returns with average starting valuation of 13.25.
WORST FOUR DECADES
-1.41% annualized returns with average starting valuation of 24.5.
Notice the difference? Cheap starting points resulted in better returns, and paying too much ended up with losses.
The problem is, of course, where we are now with a CAPE ratio of 26.5. I would argue Millenials are actually smarter than they look and that they are correct in avoiding stocks. That is depressing but is the unfortunate reality. However, not all is lost.
Valuations for equities around the world are much, much more reasonable at an average CAPE of about 15. And if you’re willing to be a little different, the average CAPE of the cheapest 10 stock markets around the world is ridiculously cheap at about 8.
So my advice to Millenials (and Gen X and Baby Boomers alike) is this – don’t abandon stocks, but consider the below steps to improve your chances of better returns
-The bad news is the US stocks are expensive, although not in bubble territory. The good news is most of the rest of the world is quite cheap.
-At a minimum, allocate your portfolio globally reflecting the global market cap weightings. In the US, that means allocating 50% of your portfolio abroad. Likely you have home country bias and invest about 70-80% of your assets in the United States.
-To avoid market cap concentration risk, consider allocating along the weightings of global GDP. This would mean closer to 60-80% in foreign stocks.
-Similarly, ponder a value approach to your equity allocation. Consider overweighting the cheapest countries and avoiding the most expensive ones. Currently, this would mean a low, or zero, allocation to US stocks. Note: This does not mean simply picking one or two countries, but rather a basket of the cheapest countries – 10 is a reasonable number.
If you want to read some more on equity valuations I have a short book on Amazon called Global Value. It’s only $5 and you could probably read it in an hour or two. If you promise to write a review I’ll even send you a free copy just enter your email here..
