Arnott Says Stocks Will Fall, Buy Global Real Estate

Table of Contents

The crash is far from over

The big picture:
Investors with new capital should exercise caution in allocating their money. Reviews are key. I see the rebound in tech stocks as a dead bounce of speculative growth. It’s very typical to get bounces when a bubble bursts. That’s a big problem, but it’s being triggered in part by falling inflation, which some people interpret as, “Oh, you can go back to those meme stocks.” No, the crash is far from over.

The idea:
I would frame a discussion of where to invest around three fundamentals: long-term thinking, diversification, and risk management in relation to your human capital – where you work, where you live. If you live in the US, consider non-US and emerging-market stocks. If inflation would hurt your income, consider Treasury Inflation-Protected Securities (TIPS), global real estate, and master limited partnerships in energy and other resources. If you’re exposed to trending growth companies in your work or in your portfolio, consider value investing outside of the US, where geopolitical concerns have pushed them into bargain territory.

In the US, small-cap value stocks are pretty much the only thing cheap. The S&P 500 is back above 30 times earnings using the Shiller price-to-earnings ratio. [The so-called CAPE ratio uses inflation-adjusted earnings from the previous 10 years.] Small-cap value is trading under 20x — it’s not cheap, but it’s not bad. International value trades at 11x 10-year earnings average and emerging market value at 9x sustained long-term earnings. That is cheap. People call me a permanent bear, but I’m not a bear when it’s cheap.

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If I had to choose between small-cap value, TIPS, global real estate, international value, and emerging market value, the last three would be the most interesting. These three would give you a more focused return-oriented strategy with less diversification, but you could do a lot worse than invest 20% in each of the five. Each of the areas looks great from a risk-reward perspective, and each is probably good diversification for the typical US investor given where they carry most of their personal risk.

drill down:
The events of the past year have produced some pretty good bargains. Our model shows international value with an annualized return of 13% per year over the next 10 years, with risk no higher than that of the S&P 500. In the meantime, we predict that an S&P 500 index fund will give you around 5.5% per year (up to 2.5% a year ago, before the bear market). Emerging market equities and global real estate will be a bit more volatile, with projected returns of around 14% and 8%. TIPS is the lowest risk strategy, and if you invest in long-term TIPS, the return is around 1.5%. Our 10-year inflation forecast is 3.5%, so you get 5% with very little risk. You’re also protected if inflation picks up again. The US small cap stock is around 9% yield. A basket of the five holdings would earn you just over 10% every year for the next 10 years.

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