(Editor’s Note: This is another timeless article with worthwhile investment input because it makes the case that a pricey stock market is often a cautionary flag, prodding prudent investors to consider diversifying into additional asset classes. The last time the price-earnings ratio of stocks was as high as it was in fall 2021 was 1999, which a few months afterward was followed by a sell-off and a recession. Two decades later, Wall Street’s imperviousness to bad news in the latter months in 2020 and much of 2021, enabling stocks to double in value from their pandemic lows, showed signs of cracking in the waning months of 2021, reflecting concerns about inflation and rising interest rates.
Many pundits have become less enthusiastic about stocks, but not outright negative. They think the market will remain static or mildly down for a while and then slowly rebound in 2022, with the S&P 500 rising about 10% from late 2021 to the end of 2022. They say the market will be fueled by rising profits, overriding modestly rising interest rates.
Whether this theory actually becomes reality, of course, is ultimately unknown. That’s why it’s almost always worthwhile to consider complementing stock investing with alternative investments, which seldom follow the same path as the stock market. That is the primary theme of this article.)
It’s always a good time to review your investment portfolio. If you’re an average long-term investor – which means you have an investment mix of roughly 60% stocks and 40% bonds, and perhaps some annuities as well – you are probably a happy camper.
Stocks have been sloping mildly downward of late but set a number of new highs in 2021. Many market watchers anticipate additional new highs in 2022 because continued economic growth and higher corporate profits is widely expected. The outlook for bonds is less rosy – rising interest rates are chipping away at bond prices, and rates are expected to continue to climb.
Overall, this still boils down to a relatively good market backdrop, given that the stock market, the main financial player, still sits near record highs and is likely to begin declining at some point. Still, you couldn’t fault a prudent investor who contends that the market is obviously closer to a peak than a trough and that bonds are have become unattractive. All it takes to shake things up is one negative event, such as yet more heightened friction with China.
The Shiller P/E ratio, named for Yale economics professor and Nobel Prize winner Robert Shiller, compares current prices to average earnings over the past 10 years, adjusted for inflation. It is pushing 30, the highest it has been seen 2002 and almost double its long-term average. Besides 2002, the only other time the ratio was so high was 1929 — the year of the infamous stock market crash that ushered in the Great Depression.
So what should a savvy investor do? To borrow a word from an earlier paragraph, be prudent.
No panic is necessary. The stock market will not fall off a cliff. But it is a good idea to move some money out of the market, in particular, and put it into a so-called alternative investment – one that doesn’t track the trajectory of stocks or bonds. Or, if you are a pre-retiree or retiree and have not already done so, it might be a good idea to buy an annuity offering guaranteed lifetime income. It’s all about weatherproofing your portfolio. And, in the case of annuities, it’s insuring that you have a supplemental income stream regardless of how markets perform.
One type of alternative investment is a Business Development Corporation (BDC), created by Congress in 1980 to help middle-market companies. It serves as a bank of sorts, lending money to a diversified mix of middle-market companies and sometimes investing in them. A number have produced very respectable returns. Another type of alternative investment are REITs and other types of real estate investments. Both follow a different path than stocks or bonds, enhancing diversification.
Annuities – for those who don’t already own them – are all about locking in guaranteed income streams, lifetime or otherwise. In effect, many are pensions, funded by insurance companies.
What makes annuities particularly attractive to the older set is that they mitigate or erase the fear of gyrating markets. Nobody likes a bear market. But it’s more unsettling if you’re retired and rely on your investments for most of your income. Annuities and alternative investments also sidestep so-called sequence of return risk, a fancy name for the fact that most retirees withdraw funds regularly from their retirement accounts — and that doing so in a down market pummels the chances of a rebound.
For those who like the stock market’s enviable long-term growth potential, a particularly attractive annuity today – if carefully selected – might be a fixed indexed annuity. These invest in an index, often the S&P 500, and do not mirror the full upside of index performance. On the other hand, a FIA, unlike the index, doesn’t lose value in a down market. Most are also sold with a provision of guaranteed lifetime income.
A FIA could be just what the doctor ordered today if you’re a long-term fan of the market but worry about today’s pricey stocks.
In a recent interview, Shiller told CNBC that it’s virtually impossible to accurately predict short-term market moves. But this doesn’t mean investors should do nothing, he added. “Current stock prices would suggest reducing your holdings of stocks, especially for a long-term investor,” Shiller said. “We can’t time the market accurately, but we know that when it’s this high, over the long term it usually doesn’t do great.”
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