Stocks
For the S&P500, we are at 21.2x 2025 consensus earnings, a rich valuation that should temper enthusiasm on future returns. Future returns are first and foremost a function of price paid and, at these prices, lower forward returns are likely.
We can follow the lead of certain pundits and attempt to rationalize (“bullish rationalization” is what you do in strong markets) this heady valuation by stripping out the MAG 7 – Alphabet, Amazon, Apple, META, Microsoft, Tesla and Nvidia – to arrive at a lower valuation. This operation leaves you with a p/e of 18.4x for the S&P500 minus the MAG 7. The argument here goes that the MAG 7 are incredible companies that are winning massively in our increasingly winner-take-all world, thereby meriting the 35x valuation the market is currently awarding them. While sounding a little like all “this time is different” arguments, this MAG 7 apologetic can be offered with a straight face, not least because these companies are intensely innovative and long-term focused. To a company, they are making huge investments in AI and other cutting-edge technologies, technologies that just might rule the world. Within the MAG 7, you find five of the globe’s top six R&D spenders, spending 13-30+ percent of massive revenues on R&D. Said another way, these companies are in no way pulling the levers to manufacture higher earnings this year, thereby delivering the low p/e readout the value-minded investor covets.
Case in point, Amazon spent a reported $86B on R&D in 2023. A little thought exercise would tell you that Amazon could cut spending and print about any gaudy earnings number they like.
On the flip side, present valuations mean a lot of good stuff is baked in the cake. 35x earnings on trillion-dollar companies implies a steady stream of good stuff for many years down the road. Further, this argument has embedded within it another source of concern: the winner-take-all argument shouldn’t leave investors feeling warm and fuzzy about paying 18.4x earnings for those companies outside of the MAG 7 “winner’s circle.”
Looking ahead, analyst consensus calls for strong earnings growth into 2026, with estimates pegging S&P500 earnings at 311.4. This implies a p/e of 18.7x on 2026 earnings. In a world with President Trump at the helm, I’m focusing here on his business-friendly approach and steady attention on the stock market, one could easily envision that corporate earnings will surprise to the upside. We could also envision a market that remains in a good mood, applying a fat multiple to earnings.
If Trump implements a broad-based tariff regime, it is largely a mystery how it will impact this 311.4 earnings figure. It could be a great policy move that works for American workers, but it is hard to pencil out the impacts. Investors love certainty, so put this down as largely an item of concern.
Because the market is expensive, some investors will be inclined to go to cash in order to wait for a better entry point. In my view, the complication may outweigh the merits. The 200-day-moving average is only 5% below current levels and strong earnings growth under Trump could rework valuation metrics. There might be no pullback to buy. The S&P500 went over 44x earnings in 2000 with the “dot.com boom” and that’s a long way up from here. For many reasons, let’s hope we don’t see anything resembling that boom.
For conservative investors, because there is a significant likelihood we could see elevated inflation going forward, you must maintain a significant allocation to equities. Circumstances vary widely and the right allocation requires a financial planning exercise but, for most, an inadequate allocation to risk assets creates a misallocated portfolio that fails to protect one’s purchasing power.
Bonds
Rates are rising and many pundits cite the United States’ twin deficits as the culprit. The budget deficit and $36.2T in total outstanding debt are problematic but, in my view, this rise in rates is simple normalization back toward historic rates. Market participants are newly focused on the threat of inflation after the first bout of dramatic inflation in forty years, leading me to interpret this normalization as both prudent and orderly.
We have been treated to rising national debt and periodic debt ceiling showdowns for years and rates remained low in the face of this. We have entertained wild ideas like a one or thirty-trillion-dollar coin, owing to a 1977 law that allows Congress to mint platinum coins in any denomination. If the Treasury market scared easily, that $30T coin conversation should have sent a shiver and it did not.
For a period of almost three years ending in the Spring of 2022, the ten-year note yielded under 2%, and spent almost the entire year after the COVID outbreak bouncing between .5% and 1%. https://fred.stlouisfed.org/series/DGS10
At current levels, US Treasuries present a compelling risk-reward opportunity. It is the safest asset class available, the epitome of too big to fail, and the rich stock market now offers the thinnest of risk premiums. I’m pretty happy to plug some cash in a five-year note yielding 4.7%. If market rates rise from here, hold the five-year until maturity to avoid realizing capital losses and plug additional funds into still more bonds to get the higher rates.
REITs
The present pricing of REITs posits a real-time argument against the Efficient Market Theory. At a time when overall delinquency rates are in a well-worn rising groove and office delinquencies are at 11%, a figure that surpasses the high-water mark seen in the Financial Crisis, REIT yields trade well below Treasury yields. Since REITs are required to pay out 90%+ of their income to unitholders, REITs should be evaluated as a true income play. Why would a far riskier income-based investment pay less than US Treasuries? It makes little sense.
Just this week, I sat in on a long-short hedge fund call in which the investors detailed their short position on REITs. Their logic was rock solid, but I will not be following them in making this bet. Instead, I will simply avoid investing here until better values are offered.
I will digress to add that I always strongly advise investors to avoid short positions. There are too many ways to get burned on the short side. 1) Long/short funds have largely gone the way of the dodo bird because it’s been very hard to play the short side with the value of most things rising. 2) Consider the cautionary tale of GameStop or AMC where the Apes punished the big guys. 3) Consider Volkswagen and the short squeeze that made the dowdy automaker the most valuable company in the world for a short time in 2008, when no one thought of VW as even being in the conversation of most valuable companies. VW got wildly overpriced, but if you made a big short bet, you went wildly broke before it came back to earth.
Gold/Silver
The sceptic will say gold is an unproductive asset … like a pet rock.
I will join the sceptics to add that gold may not be all that it’s cracked up to be for the apocalyptic-minded prepper. In gaming this out, someone has said: when you try to buy a loaf of bread by shaving a little gold off of your gold bar for payment, you are going to need a few big guns to keep them from taking the bar.
Gold bugs will tell you that gold is the only asset that isn’t someone else’s liability; that it’s one of the best stores of value around if we think about what will be valuable 50, 100, 250 years from now. From Ray Dalio’s recent book The Changing World Order: “of the roughly 750 currencies that have existed since 1700, only 20 percent remain, and all of them have been devalued.” In a world of fiat currency and growing sovereign debt, central banks are buying gold hand over fist. I like gold as a store of wealth. I like it as a noncorrelated investment in a diversified portfolio. I like it for purchasing power protection, though it doesn’t closely track inflation rates over shorter timeframes.
I also like silver which trades at a very depressed level relative to gold. The gold/silver ratio is now at roughly 89, meaning an ounce of gold is 89x more valuable than an ounce of silver. Over the last fifty years, this ratio has often been 20-60x. Silver is heavy and not all that precious, making it an inferior store of wealth, but as investors looks for alternatives, one could imagine silver being more widely adopted in a way that pulls this ratio back in line with historic norms. This would most likely be accomplished through a significant increase in the value of silver.
Bitcoin (BTC)
Making the bear case over the weekend, Jamie Dimon, the CEO of J.P. Morgan and the closest thing global finance now has to John Piermont himself, told CBS Sunday Morning that he sees “no value” in Bitcoin. “Bitcoin itself has no intrinsic value … It’s used heavily by sex traffickers, by money launderers, ransomware. So, I just don’t feel great about Bitcoin.”
In other recent news, experts highlighted the risk that quantum computers might pose to BTC, namely that the new quantum chips (like Alphabet’s Willow chip) could be leveraged by bad actors to break in and decrypt encryption codes. This appears to be a real possibility but BTC experts believe quantum resistant encryption can salvage the asset class. My guess is that this quantum computing risk isn’t entirely unique to crypto and might be best viewed through the ever-increasing focus of all things cybersecurity. I don’t know that anything in the digital realm is safe in perpetuity absent the constant cybersecurity work of tech upgrades, fixes, patches, updates, etc.
On the bull side, for some reason, President Trump is friendly to crypto and his win on November 6 helped BTC rally 62.3% over the six weeks ending December 17. As I’ve written previously, the BTC rally is one epic trend trade and with BTC’s absence of classic fundamentals to anchor its value (for example, you can’t apply a multiple to annual earnings), what will keep BTC from reaching $1M per coin? $1M is no less logical than $100,000. I still don’t love BTC but the best approach to BTC would seem to be a technical trading approach that seeks to buy pullbacks that are either significant or to key support levels, and then to ride the train. Three times in 2024, the 200-day moving average provided strong support, and the 50-day moving average has provided key support through the years for those eager traders willing to buy on a smaller pullback.
Cash
With cash, you get the wonderful gift we all prize: optionality – the ability to do anything we desire to do tomorrow, and the certainty you will avoid the regret of a dollar poorly laid. With cash, you escape the vicissitudes of daily volatility but if you hold on a long time, you exchange gut-churning volatility for the one asset class best positioned to meaningfully erode your purchasing power, racehorses and vineyards omitted. I talk to far too many people sitting on significant cash, and they have often been holding it for a long time. To all of them, and to all readers, I share the inflation calculation tool found here: https://www.minneapolisfed.org/about-us/monetary-policy/inflation-calculator. This is a pretty fun tool to play with. For example, you will find that a dollar has lost more than half of its value since 1996, when measured against a basket of goods and services. The takeaway is that you have to do something productive with your assets.
See also the Parable of the Talents.
Choose wisely!
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