Don't Trust TINA
Have you heard about TINA? That’s the new acronym making its way around financial circles. It stands for “There Is No Alternative.” It means investors are reaching for yield from risky investments because they feel they must in absence of acceptable yields from less-risky alternatives. TINA is pouring money into stocks and bonds, driving their prices higher. This can be dangerous in absence of support from breakout growth in the economy.
Stocks and bond valuations have been generally high for some time now. Currently, based on a look at historical lagging PE for the S&P 500 (through August 17), lagging PE is 25.29 times reported earnings. The long-term average is 15.60 times (source: Mutpl.com), so the stock market’s valuation is indeed high. Bond markets are even higher.
Given this, four scenarios are possible. The first is that valuations rise even higher in expectation that the economy will experience breakout growth that eventually leads to robust corporate earnings. This could play out because markets are forward-looking. But the recent long period of economic sluggishness seems entrenched, so it seems unlikely.
Another scenario could be that valuations stay high no matter what happens in the economy. This could come to pass if central banks maintain easy monetary policies because low interest rates tend to support high valuations. This would be the status quo scenario.
Third, valuations could slowly drift down to normal levels via an extended period of low returns — or, lastly, we could see valuations quickly come down via a market selloff. Each of these latter two events seem more likely than the former two because reversion to a long-term average is always a high-probability event.
So while stocks and bonds have produced terrific year-to-date returns, almost all of the stock gains were attributable to multiple expansion rather than a big improvement in the economy and corresponding strong earnings growth. As such, it is reasonable for investors to expect low returns and/or meaningful corrections.
These probabilities tell us that TINA should be ignored. Low returns from safe investments are indeed a bummer. But precipitous losses from risky investments during a selloff are worse.
One final thought: If Milton Friedman was right and all of the recent aggressive money creation by central banks leads to unexpected inflation, things could get ugly – fast! There is no current indication that inflation will soon be a problem, but that’s what would make any new inflation unexpected.
These words of caution are not a call to sell stock or bond positions. Rather, they are a call to include low returns and a meaningful correction on the list of more probable scenarios. As human beings, we don’t make self-defeating investment decisions when expected bad things happen. We make them when we’re ambushed by bad things.
Setting reasonable expectations based on probabilities would be very value-adding regardless of which scenario plays out. Even so, caution is timely.