Asset allocation in a US stock market bubble

[letitroll]

 

[SquirrelChaser]

If I were to steelman the other side.....one might argue that the stock market investors....are looking through current bond prices....to a future period when they return to much lower levels.....such that they are front running an expanding ERP by owning stocks now knowing that there is a bond rally to come. I'm not so convinced........i think the US has worked for so long....that its going through what has all the appearances of being a melt up.....as investor pull funds from across the globe in under-performing markets to pile into the asset class with the best 3,5,10yr record....SPY/QQQ....

That seems likely. Nobody is currently talking about increasing interest rates- or as of yet a return to quantitative easing.

There are other elements to the equation though- economic factors of production. Of those labour is increasing and arguably so is enterprise. Technology (which effectively leverages land, labour, capital and enterprise) is advancing exponentially. All of which points to a growing world economy (Google says only 2 years of negative growth since 1961) in future, which will likely be much greater in those countries which have the greatest share of the factors of production- and it's difficult to argue that the US doesn't have the lions share of capital and technology, and its labour pool isn't exactly small either.

And it's also difficult to argue that the US doesn't encourage the growth of oligopolistic megacorps which dominate the stock markets. So US indices go up faster and attract more capital providing more opportunity growth etc in a feedback loop.

This isn't a voice in support of the US economic model- economy and society (ie people) are synonymous, and I'd far rather live in Europe with an excellent social safety net (which I've needed before and am likely to need again).

But while I hate the thought of living in the US, it's certainly where I put my money to work. Hypocrisy at its finest i admit.

 

[joe sod]

I'm not so sure about this - Russian cheap energy is not coming back in a timeframe that matters for Europe's industrial competitiveness....looks to me like Europe is now operating with energy prices that are now two to three times structurally higher than the US.

IMO European equity market outperformance will come more from a re-pricing downwards of US assets than some marked improvement in underlying European company performance.

but thats exactly what happened after dot com crash, it was more that the US markets full of tech stocks and which had the super performance during 1990s fell along with the dollar a double whammy for international investors. Europe became a relative safe haven, also the oil price actually rose during the early 2000s as commodity stocks were re priced upwards after hitting historic lows, this also happened during covid when the oil price hit an historic low in 2020 with Russia Saudi oil price war.
I maintain it is a big mistake to just focus on the US markets.

 

[Dr Strangelove]

I maintain it is a big mistake to just focus on the US markets.

But the US equity markey is basically the world excluding Russia and China. Look at the top 25% of S&P now:

Apple (AAPL): 7.05%
• Microsoft (MSFT): 6.54%
• Amazon (AMZN): 3.24%
• NVIDIA (NVDA): 2.79%
• Alphabet Class A (GOOGL): 2.13%
• Tesla (TSLA): 1.95%
• Alphabet Class C (GOOG): 1.83%
• Berkshire Hathaway (BRK.B): 1.83%
• Meta Platforms (META): 1.81%
• UnitedHealth Group (UNH): 1.28%

All of the above (except United Health Group) have revenue from basically all over the world.

 

[joe sod]

But the US equity markey is basically the world excluding Russia and China. Look at the top 25% of S&P now:

All of the above (except United Health Group) have revenue from basically all over the world.

Top 20 S&P 500 companies by market cap in 2000
(as of 1/1/2000, in millions USD)

2000​

Total: 4,193,260​

604,410Microsoft
397,930General Electric
355,120Cisco Systems
307,880Walmart
280,120Exxon Mobil
274,430Intel
200,660Citigroup
184,060IBM
158,090Oracle
157,880Home Depot
148,930Merck
143,970Coca-Cola
142,370Procter & Gamble
140,330AIG
129,410Johnson & Johnson
124,740Qualcomm
121,060Bristol-Myers Squibb
118,220Pfizer
117,540AT&T
86,110Verizon

it was the same in 2000 remember, all the top tech stocks were global,
It was probably a bit more diversified in 2000 than it is today though. I wouldn't consider Berkshire to be a truly global stock it is mainly invested in the Us with a smattering of Jap and european holdings. Also eurostoxx 600 would have big corporations with global earnings too

 

[Dr Strangelove]

It was probably a bit more diversified in 2000 than it is today.

I am eyeballing here but I would say that the top 20 in the S&P500 today get more revenue from outside the US than they did in 2000. Look at on your list GE, Walmart, Citi, Home Depot, etc, which all got vat majority of revenue from the US market.

My point is that US stocks are inherently diversified globally.

 

[Corola]

I maintain it is a big mistake to just focus on the US markets.

My point is that US stocks are inherently diversified globally.

These can both be true at the same time.

 

[letitroll]

That seems likely. Nobody is currently talking about increasing interest rates- or as of yet a return to quantitative easing.

Hard to know - I think the case for higher rates due to inflationary forces (deglobalization, labour markets, re-armament, greenification) appears like the most compelling thesis I've seen for where rates are headed in the next decade.....on the other side of that you've got deflationary AI and simply the debt levels on sovereign balance sheets....that need lower long term interest rates to make the fiscal math work for the politicians.......and so you'll get the Japanification of the US/EU's...low short term rates + yield curve control via CB targeting/interventions further out....

There are other elements to the equation though- economic factors of production

Yep - the US undoubedtly has the finest set of cards a nation could hold when you factor in access to financial capital, human capital, energy, reserve currency status, geographic location ala security, strategic autonomy via military strength ......it's a very envious position......but no asset or asset class is so good that it cant be made a bad investment by raising its price sufficiently.

 

[cremeegg]

I prefer to think of things in terms of probabilistic prospective returns......in that context US indices.......specifically their current operating earning multiples and then the underlying profit margins of its constituent companies are at historically elevated levels.....by some measures about as high as they've ever been

So probabilistically.....one would not choose these levels......if you we're seeking say the 9- 10% historical annual returns that US markets have enjoyed in the past to play out for the next decade....to do so, to get to that 10% annualized return.....would require somewhat implausible things to happen from right here, right now:

(1) that investors, paying already elevated multiples of earnings, would decide to pay even more.....such that you would get continued sustained earnings multiple expansion on top of earnings growth that would plateau at some level higher than where we are today or have sustainably been ever....I'm not saying this cant happen in the short run.....markets can trade anywhere at anytime before returning to rationality.....SPY/QQQ multiples can go higher in the short or even intermediate term.....but they've historically never persisted at these multiples for any great length of time....in periods where multples we're elevated the general stock price level has been sustained and grew in these instances by underlying profit growth (margin expansion etc.) such that multiples came down as the earnings expanded.......but today we get to no (2)

(2) that US profit margins (already historically elevated) would expand further from here.....we are in quite rarified air in terms of margins....that they would expand from here to support stock prices as say the underlying earnings multiple contracted to more average level also seems implausible.

Valuation is not a short term timing tool......rather its a probabilistic expected return tool... probabilistically.....expected 10yr returns are low for US indices.....when you overlay the fiscal situation in the US....running 6-7% budget deficits during a period of full employment....what you also realize is that the US government via borrowing & spending is stimulating US economic activity at an unprecedented level for peacetime....and in a very real sense this fiscal borrowing is flowing through to US corporates as elevated profit margins and profits...and to the public as excess liquidity from which they can speculate on the stock market in their 401k's and Robinhood accounts......whether this continues or not will have a large bearing on what happens next to earnings and folks enthusiasm to buy a claim on those earnings.

For an Ireland based investor......SPY & QQQ....present real challenges IMO...everything I've highlighted above.....to which you can add currency risk......given the current EUR/USD exchange rate....which again is at something of a historical high (albeit SPY/QQQ has some natural hedging given the international earnings profile).

I say all this for the indices......there are plenty of companies that have plausible and probable avenues to provide an investor with high single digit 10yr returns.....and assembling a basket of these would make more sense than relying on expanding enthusiasm for SPY/QQQ right now

No.

Future returns will be based on the success or failure of the electric conversion, AI, revolution in healthcare.

If AI lives up to its hype, current earnings multiples and profit margins will be irrelevant, if it doesn't, current earnings multiples and profit margins will be irrelevant.

 

[joe sod]

Hard to know - I think the case for higher rates due to inflationary forces (deglobalization, labour markets, re-armament, greenification) appears like the most compelling thesis I've seen for where rates are headed in the next decade.....on the other side of that you've got deflationary AI and simply the debt levels on sovereign balance sheets....that need lower long term interest rates to make the fiscal math work for the politicians.......and so you'll get the Japanification of the US/EU's...low short term rates + yield curve control via CB targeting/interventions further out....


Yep - the US undoubedtly has the finest set of cards a nation could hold when you factor in access to financial capital, human capital, energy, reserve currency status, geographic location ala security, strategic autonomy via military strength ......it's a very envious position......but no asset or asset class is so good that it cant be made a bad investment by raising its price sufficiently.

yes I agree fully with this, because of high government debt globally inflation is needed to wipe out the effect of that debt, therefore we will have an inflationary environment for a long time to come. With all the advances in AI and technology etc these are all energy intensive endeavors yet no real advances have been made in energy generation, Microsoft are going back to nuclear as the only effective and reliable energy source to power all this technology, they are even looking at the 3 mile island site to restart nuclear reactors that were stopped in 1979. Very little advancement has been made in energy throughout this period therefore energy prices are likely to be very high into the future (I am contradicting myself here somewhat regarding european energy prices I know). You just have to look at irish electricity prices the highest in Europe even with all those renewables on the grid , so renewables are contributing to this whole inflationary environment we are now in. Therefore whatever about US stocks I definitely would not be buying government bonds in this environment

 

[letitroll]

high government debt globally inflation is needed to wipe out the effect of that debt, therefore we will have an inflationary environment for a long time to come

Yep the book says - you run the economy hot to get out from under your debt pile.....nominal GDP growth at say 6%...2.5% real growth, 3.5% inflation....while your Central Bank keeps rates lower than they ordinarily should......with some likely yield curve control on the mid to long dated issues required....in effect your really just 'burning' the bondholders (in Celtic Tiger speak).....well less burning.......and more boiling them slowly so they barely notice they're being cooked.

The formula only works of course if the US government shrinks its budget deficit back down to 2 or 3% annually......lower than nominal GDP growth......such that debt to GDP is shrinking YoY.....no mean feat....when the demands on social security and medicare are rising with retirees.

The one thing not talked about so often though is just how poorly the Treasury in the US has termed out its debt pile.....they did an amazingly poor job of this with something like 60% of the federal debt pile coming up for renewal in the next few years.....interestingly lots of US corporates too are coming into a maturity wall too where their debts roll into much higher paper...2025 into 2026

Our own NTMA - should be applauded...I looked at Ireland's maturity profile and its benign by comparison.