In recent months, there’s been a lot of handwringing about the stock market. Thankfully, we seem to be on the back end of the pandemic, but things remain far from perfect in the economy. Millions are still unemployed. And the government has had to spend trillions to get us through, adding to a federal debt that was already enormous. Today the economy is far more fragile than it was pre-Covid. And yet, the stock market just keeps cruising to new all-time highs. The S&P 500, including dividends, is up more than 11% this year. That’s on top of last year’s gain of more than 18%.
While the bond market receives less attention, there’s been a similar amount of handwringing there as well. The yield on 10-year U.S. Treasury bonds, despite a recent rise, still stands at a meager 1.6%. Even a 30-year Treasury today offers investors just 2.3%. And because bond prices move inversely to yields, this means that bond prices are also near all-time highs.
This has many investors asking: If both stocks and bonds are challenging, is there anything better behind door number three? Let’s review the options.
Gold and cryptocurrency have been gaining attention because they’re seen as effective hedges against inflation. But as I noted last week, they are risky because they lack intrinsic value. There is no tangible basis on which to value them. That means they’re only worth what the next person is willing to pay for them. And while gold has a longer track record than cryptocurrency, that record is unimpressive.
More broadly, commodities have appeal as a tool for diversifying portfolios. In addition to gold and silver, you can invest in everything from wheat and corn to crude oil and natural gas. And there are index funds that make it easy to invest in a basket of commodities. The challenge, though, is that commodity prices are notoriously volatile. In addition, they don’t offer the inherent growth potential of stocks, and they’re not stable enough to replace bonds. For these reasons, they can play a role in a portfolio, but only a supporting one.
Private funds are another alternative. If the public markets are all trading at high levels, the thinking goes, maybe I can do better with a private fund. There is logic to this, but they carry their own challenges: Compared to public funds, private funds have lower transparency, lower liquidity, higher minimum investments and higher fees. And they can be a pain at tax time.
All of those drawbacks might be worth it if private funds were knocking it out of the park with their performance. And some certainly do. But here’s the problem: According to a study by McKinsey, the dispersion of returns among private funds is much wider than among public funds. This means that when you’re investing in private funds, it’s much more important to choose the best funds. But those funds aren’t generally open to mainstream investors. Why is that? Private funds are capped by law in how many investors they can take on. So if a fund manager has a top-quartile record, he or she would much rather take a seven-figure check from a university endowment than a smaller one from an individual investor. Bottom line: Even though some private funds have delivered enviable results, I don’t see them as a practical solution—certainly not for the majority of one’s portfolio.
Taken together, this lack of viable alternatives has given rise to the acronym TINA—There Is No Alternative. That is, there’s no alternative to the stock market. Investor frustration with TINA helps explain, I think, why we’re seeing some of the more bizarre corners of investment markets become so inflated. This includes things like dogecoin, which has gained more than 10,000% over the past year. And it includes non-fungible tokens (NFTs), like the cartoon image of a cat that sold for $580,000.
Craziness like this is a symptom, in my opinion, of the fact that investors are searching high and low for something—anything—that offers better prospective returns than the stock market.
I have good news, though: You don’t need to buy into the TINA trap. Yes, the S&P 500 is pricey. But that’s not your only choice. There are other segments of the stock market that are still reasonably priced. Most obviously, this includes value stocks. The Russell 1000 Value Index, for example, is trading at 18 times forecasted earnings. That’s a steal compared to the Russell 1000 Growth, which is trading at 31 times.
Outside the U.S., the MSCI Europe, Australasia and Far East Index of developed countries is trading at 17 times earnings, and the MSCI index of emerging markets countries is trading at just 15 times. Do these markets deserve to trade at discounts to the U.S.? I think so. But the valuation gaps have grown over the past ten years, meaning that these markets have become less expensive even on a relative basis.
How can you take advantage of these more attractive valuations? It’s not difficult. All of these market segments can be accessed with simple index funds. If your existing portfolio consists of a total-market index fund or an S&P 500 fund, that’s no problem. You could make the change in a retirement account, where there would be no tax impact. Or in a taxable account, you could simply add a value-oriented fund or an international fund the next time you have dollars to invest. Over time, this will give your portfolio a “tilt” toward the less expensive side of the market. This, I think, offers a practical alternative to the view that there is no alternative.