Don't Completely Give Up

There was some interesting reading yesterday that I think continues on the conversation we've been having this week about ETF portfolio construction and the extent to which portfolio construction might evolve.

Felix Salmon asked Why People Invest In Stocks now that, in his opinion, there is "no good reason to expect an equity premium going forwards, and if there isn’t an equity premium, then your allocation to stocks should be tiny."

This takes me back to the idea I have repeated from Taleb about 90% t-bills from around the world and 10% going berserk with volatility. Perhaps I am reading Felix incorrectly but I pick up a tone that not only is equity premium gone but that it won't come back. This is an important question that is always worthy of consideration but I believe it is easier to believe that the equity premium might be gone in the immediate wake of one of the worst decades for US stocks in modern times. Meaning stocks are less likely perform badly after they just performed badly.

"Tiny" was not quantified in the article but maybe tiny could mean 25%. Someone to whom this appeals needs to do a couple of things to avoid the consequence of being too conservative. First thing is save more money. If a portfolio has less exposure to risk assets then it has less chance appreciating so the difference needs to come from increased savings. Investing in risk assets takes on the presumed benefit of compounding at a rate greater than 1-2% but 25% in equities changes the dynamic.

In addition to saving more, the fact that the tiny portion would need to do more heavy lifting means that some sort of active action needs to be taken--obviously this is just my opinion and would be in complete disagreement with what Felix appears to be saying. "Some sort of active action" could simply mean an ETF mix that avoids the worst parts of the market like Europe, Japan and the US banks.

The idea of someone realizing that 70% equities was too much for them and making the decision to cut back to something like 50% is a reasonable reaction to the last decade and 2008. Someone taking this more moderate approach should probably save more money (but shouldn't we all?) but they would not be giving up the opportunity for compounded growth at a reasonable rate.

Deciding to shun risk assets after a bad decade for risk assets has the potential for some very bad consequences. I can envision a "whole generation" of investors giving up on equities at precisely the wrong time because they are told the game is rigged and that the stock market does not work. How rigged will people think it is if come May 19, 2020 the S&P 500 is at 4480 (quadrupling in a decade is not unprecedented)? 4480 is not a prediction, I have no idea about 2020 but a fantastic ten year run after a period of years where the market does very poorly would be far from a Black Swan event and I would not want that to happen without me or my clients whenever it might start; 2010, 2015, whenever. The consequence from a fantastic decade happening without people being in would be dreadful.

To be clear my baseline scenario is below average but positive returns for the US market with close to normal returns coming from select foreign markets.

I'll close out with a dog rescue story. This little guy curled up in the picture is Finn. Finn hopped the fence at his foster home on April 24 and had been on the run since yesterday. Joellyn and a few of her colleagues United Animal Friends spent a lot of time looking, they posted fliers where he had been seen and our phone had been ringing off the hook with news of sitings but no one caught him.

"Mike from Groom Creek" agreed to keep a trap at his house for most the time that Finn was on the loose and yesterday he caught Finn, not in the trap but with his hands which is amazing given how skittish Finn was/is. Mike took one for the team (small bite from Finn) but he was none the worse for wear and now we are fostering Finn--we have a six foot fence. Or maybe we are not fostering him if you know what I mean. A dog can last on his own like Finn did for a while but of course anything can happen as we have plenty of wild animals here but Joellyn never gave up hope.