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A couple of things happened last week in response to an article I wrote about TINA, challenging the argument that There Is No Alternative to equities.
First, someone sent me a link to an article by a well known investor and bubble expert Jeremy Grantham. The second, I joined Sharesies – mainly to see what the low-fees investment platform was telling punters about risk.
Both were kind of scary experiences.
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A fully-fledged epic bubble
Robert Jeremy Goltho Grantham CBE is the co-founder and chief investment strategist of Grantham, Mayo, & van Otterloo (GMO), a Boston-based asset management firm with quite a few billions of US dollars of assets under management. Grantham is in his 80s these days, but gained influence as an investor after correctly calling the dotcom bubble in 2000 and the dramatic GFC downturn in 2008.
On January 5 this year he wrote an opinion column which made headlines around the world.
Alongside a photo where he looks serious, even grim, Grantham gives this warning:
“The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble. Featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behaviour, I believe this event will be recorded as one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000.”
Grantham doesn’t know when this big bang will happen, and he admits that while he got 2000 and 2008 right, he was three years early on the 1989 Japanese bubble bursting – GMO got out of Japan and the market continued to rise and rise. (“There is nothing more supremely irritating than watching your neighbors get rich,” he says.)
But Grantham predicts the next few months, maybe years, will be “intellectually exciting and terrifying at the same time”.
“Every career incentive in the industry and every fault of individual human psychology will work toward sucking investors in.”
– Jeremy Grantham
“These great bubbles are where fortunes are made and lost – and where investors truly prove their mettle. Positioning a portfolio to avoid the worst pain of a major bubble breaking is likely the most difficult part.
“Every career incentive in the industry and every fault of individual human psychology will work toward sucking investors in.”
The 2021 ‘am-I-buying-at-the-top-of-a-sharemarket-bubble?’ situation is made worse because these days putting your money into equities isn’t about greed – wanting more.
It’s about wanting something. There is some awful truth to the There Is No Alternative (TINA) mantra.
Equities could be seen as the best of a series of not very enticing savings and investment options.
Young people are testing the markets
Over the past few months, I’ve had more conversations about the sharemarket with my young adult kids and their friends than I have probably had about the topic with anyone under 30 during the whole of the rest of my life so far. Other colleagues, as well as analyst and fund manager contacts, report the same thing.
The discussion stems from the problem these young people have about what they should buy with the unused portions of their pay packets.
A house? No chance.
Put it in the bank? No return.
Overseas trip? Yeah, right.
KiwiSaver? Good idea, but what if I want to use some of it later?
Bonds? Pitiful returns and big risk from interest rate rises. (Actually, I’m lying about my kids mentioning bonds – they don’t, but if they did, that would be a problem with them.)
Equities are arguably the best of a bad job. In last week’s article, I quoted long-time financial advisor and author Martin Hawes, who chairs the investment committee of the Summer KiwiSaver scheme.
Hawes has shifted his personal investment portfolio allocation from his more usual position of having 50 percent in shares and listed properties, and 50 percent in cash and fixed interest. Now it’s 55:45, and he might go 60:40.
When it’s easy to buy shares
It’s much easier and cheaper to get into the share market than it used to be, with platforms like Sharesies, Hatch or Stake offering low fees, easy sign-up, and small minimum investments. Around 70 percent of the more than 260,000 users of Sharesies are under 40. The word “Sharesies” was one of the top 10 New Zealand Google searches for 2020.
But how do you decide which shares to buy in a market which may (or may not) be about to correct or collapse?
That’s not as simple as it was, with long-standing ways investors have used to decide whether a share is a good buy or not seeming as up-in-the-air as the markets.
Take the P/E, or price-to-earnings ratio. PE ratios (the share price of a company divided by how much it makes per share) basically allow you to compare the relative value of different listed companies. PE ratios for New Zealand companies are easy to find on the NZ stock exchange (NZX) site. This what the stats look like for Mainfreight, for example.
In general, a high price to earnings ratio is a sign investors think a company is likely to make good money, so they are prepared to pay more for their stake in that company.
But of course, if investors turn out to be wrong in their view of the future earnings of the company, the high PE just means the stock is overvalued.
When good value becomes overvalued
Historically, the average PE ratio – in the US at least – was around 15. Put another way, investors were prepared to pay an average of $15 for one dollar of a company’s earnings.
Trouble is, markets have gone a bit crazy recently, and that’s hiked PE values. Sometimes to crazy levels. Tesla: 1692. Zoom: 483. Netflix: 91. Amazon: 91.
Market capitalisation is another traditionally-used matrix to judge a company. The theory is: large market capitalisation = big solid company = less risk. Until you look at what’s happened with Tesla, for example.
GMO analysts calculate that Tesla’s market cap, now over $600 billion, is bigger than the total market cap of all the other US automakers, plus all the European automakers, and all the Korean automakers, with Honda, Mazda, and Nissan thrown in. That’s despite Tesla selling approximately 100 times fewer cars than the other car makers.
“What has 1929 got to equal that?” Grantham says.
Then there’s net tangible assets per share, or NTA. That’s the theoretical value of a company’s physical assets divided by the number of shares on issue.
A cunning investment strategy used to be to look for a company whose share price was less than its NTA.
Good luck with that. As share prices have soared, so NTA values have got increasingly out of line. Mainfreight’s NTA is $7, it’s share price $68.60. At Port of Tauranga, the NTA is $1.7, the share price $7.50.
NZ has big PEs too
Back to P/Es (price to earnings ratios). Another slightly scary thing I did last week was spend an hour or so perusing the PEs of New Zealand companies. Remember the average long term PE in the US is around 15. Maybe a bit higher in New Zealand, where investment money is chasing fewer listed stocks.
Not any more. Around the top of the range of NZX stocks, AFT Pharmaceuticals has a PE of 126, Michael Hill Jeweller is at 157, AMP 191, Meridian 108, GPS fleet systems company ERoad is at 168, Kathmandu 80, Genesis 82.
How do you tell what’s value and what’s hype?
Brad Gordon is a director and senior investment advisor at Hobson Wealth Partners. He reckons in this low interest rate environment, an underlying PE ratio of 30 is justifiable, and some of the PEs rates you can see on the NZX site are reflections of complicating factors like swaps, futures, or write downs, he says.
“There’s a lot of noise in those financials and you have to adjust out that noise.”
Take Contact Energy. It’s pre-adjusted PE is 50. “But once you take out swaps and futures, it’s 30 times.”
As a relevant aside, Contact, and New Zealand’s other big green electricity generator Meridian, pose a particularly interesting conundrum for investors, says Nikko Asset Management’s NZ managing director George Carter.
Both Meridian and Contact’s share prices surged in early January when Joe Biden’s victory in the US elections became unassailable and investors piled into global green energy stocks. In particular, the massive global hedge fund BlackRock bought up big.
“You can imagine what happens to the price when a fund of that size decides to buy companies. But it’s got nothing to do with the fundamentals of those companies,” Carter says.
“It creates a dilemma for an active manager like Nikko because on the one hand you’d be nuts to buy at that price, but if BlackRock carries on holding them … It can feel like the tail wagging the dog. Those stocks could move precipitously in either direction.”
Pockets of over-exuberance
Brad Gordon says many share prices are inflated.
“It’s time to be selective in your investments. There are certainly bubbles in there. There are pockets of value and pockets of over-exuberance.”
How can you tell?
“You get good advice. We’ve got highly-paid analysts looking at these things all the time.”
Of course, Gordon is going to say that. Hobson Wealth – and plenty of other companies – advise people on what to do with their money and/or invest it for them.
Still, when things are crazy uncertain, it does seem like getting an expert involved could be useful. Like not relying on DIY plumbing when water is swirling around the legs of your bed.
Which is where platforms like Sharesies are worrying. The whole point of Sharesies is they don’t give advice. My sign-up is almost too easy. Caution is massively overshadowed by enthusiasm. “Onward!” it tells me as my ID verification is accepted. “Sweet pad,” as my house verification goes through.
There are times in the onboarding process when I think I’m going to get the stern word about shares going down as well as up; advice to do my research, especially in a massive bull market. Spiels about diversification, about the impact of Covid on the world economy. But it doesn’t really come.
True, about half way through 10,000 words of terms and conditions there is one section called “Investing isn’t always straightforward” where Sharesies tells me: “All investments and currency can go down in value as well as up. We’re not responsible if you lose money for example, if the value of your Investments goes down or a currency devalues …”
It feels more like legal arse-covering than investor protection, though it continues with something generic about markets and the economy.
“Ultimately, you could get back less than you invest. Any returns will vary over time, so income is variable and not guaranteed. The values of your Investments can be influenced by what’s happening in the market or general economy for example, a property downturn or a new government budget.”
But even this warning is pages and pages down a document not everyone’s going to read. And it’s mixed in with stuff about Sharesies systems outages and upgrades.
Still, the day after I sign up, I get an email from Sharesies with a section about risk and a link to a blog post from September 11 2018 called “What is risk anyway?”
It’s two years old; both share markets and global economies have changed dramatically since then.
It seems inadequate, somehow.
Investing or gambling?
Brad Gordon says when Sharesies first launched in 2017, he thought encouraging people who’d never bought shares to try small investments was a good thing.
Now he’s worried.
“Sharesies is not investing. It is a transactions-based business – gambling dressed up as investing. It’s the same thing with [US-based commission-free trading app] Robinhood. People locked into their homes and looking for something to do.”
Sharesies co-founder Leighton Roberts disagrees. He says Sharesies is designed to be a “wealth development programme”, not a platform for frequent trading where users try to time the market.
“Most people aren’t here to try and gamble. They’re here to genuinely try and develop their wealth,” Roberts told Stuff last week, in response to an article about the risk of young and inexperienced New Zealand investors buying shares in smaller listed companies, often using advice from other inexperienced investors on social media chat sites.
Roberts said Sharesies publishes investor education content that often uses “think twice” language. Its advice to investors is to invest what they can afford regularly, diversify their product, and hold investments over a long period of time, he says.
“With those three things people should do just fine.”
Markets always go down in the end
Nikko’s George Carter is worried a bad experience in a downturn will put these new and enthusiastic investors off – possibly for good.
“We know markets will go down. My worry is there are people who have invested in the market but aren’t prepared for what it looks like when your balance drops 10-30 percent.”
And it’s worse if the market does turn out to be pretty close to the top of the pricing curve.
“It’s almost a double whammy because potentially the people least prepared for a bear market have jumped in at a late stage.”
Don’t bother trying to time the market
Of course, there’s no guarantee an expert is going to get it right any more than someone on a share chatroom. Timing is virtually impossible.
“In the long run, elevated valuations here should equate to lower future returns, based on the assumption that valuations ‘should’ normalise to lower absolute and relative long term averages,” says Mark Riggall, portfolio manager at investment company Milford.
“However, timing that is fraught with difficulties and there is no reason why New Zealand share valuations can’t retain their current premium (or even attain a higher premium) for the foreseeable future.
“For investors, it pays to stick with long term investing goals and not be swayed by short term deviations in markets (up and down).”
Those dull old dividend stocks
In the end, says Hobson Wealth Partners’ Brad Gordon, we could do worse than fall back on those good, old-school, boring stocks that offer a good, old-fashioned boring dividend yield.
When you are getting 1 percent interest if you put your money in the bank, getting a 4-6 percent gross dividend yield from an electricity lines company like Vector, or a telco lines company like Chorus, electricity generators like Genesis or Contact, or retailer Briscoes is potentially a pretty good deal.
“Spark is one of our favourites,” Gordon says. PE 20.7, gross dividend yield 6.9 percent.
Even if the market crashes?
“As equity investors we don’t talk crashes, we talk volatility. Markets will get frothy and they will get oversold.”
Boring sounds OK.