The 60/40 Investment Construct Is A Cowardly Cop-Out
An enormous amount of capital in the country is managed too conservatively with shabby results. Institutional investors and wealthy families remain passive, accepting mediocre performance. Nobody challenges the widely prescribed mix of 60% in equities and 40% in fixed income paper. Inertia is a powerful force.
The amount of passive capital managed by our banks, starting with JPMorgan Chase, runs over 100% of GDP, into the tens of trillions. These days, institutional investors hide behind so-called quality paper. Not much gets invested in high-yielding bonds which have earned much more than their coupon past couple of years.
I don’t remember a time when serious investors acted so wimpy, accepting mediocre returns. Most everyone stays timid about overweighting specific sectors of the market like technology and financials. Nobody buys into the NASDAQ 100 Index.
At the bottom of the market, March 2020, sectors like oil services, natural resource plays like copper, aluminum and steel sold as ragamuffins, around five bucks a share. Stocks like Alcoa, U.S. Steel, Macy’s, Freeport-McMoRan and Halliburton went around the clock 3 to 4 times. Analysts now conjecture whether Alcoa earns as much as $5 a share next year and does the stock have legs from today’s high forties.
You need to go back 50 years, to see when JPMorgan was a gutsy player, then considered the Green Bay Packers of the investment world. Morgan, then, embraced what they labeled one-decision stocks, growthies that you held till the end of time. Price-earnings ratios were deemed irrelevant and ignored. Earnings growth would bail you out so sit tight.
Morgan adhered to this growth at any cost construct throughout the sixties but then its portfolio self-destructed in the deep recession of 1973 – ‘74. The market traded at 18.4 times earnings during 1972, not radically different than in 2000 when it exceeded 20 times earnings, where we presently dwell.
Back in 1972, premiums for growth stocks ranged up to 4 times the S&P 500 Index. Come the recession and tough worldwide competitive forces collapsed results for Polaroid, Xerox, Avon Products and Eastman Kodak. No come back. Polaroid and Xerox made me rich, then richer for over a decade but then I needed to bid them sayonara. Some 40 years ago Walmart was a small, regional discount house while Microsoft as yet was privately held by Bill Gates. Later on, Mike Milken introduced me to Sam Walton who explained his business model that was doggedly implemented. Cut out the middleman distributor.
Sadly, life for the average growth stock hardly lasts more than 5 years. Once Wall Street falls out of love with a property, it’s broken and purgatory sets in. Intel held world primacy in semiconductor technology back in the sixties, but now sells below the valuation of Caterpillar and John Deere, and rightly so.
The monument to hubris, Morgan Guaranty’s portfolio at yearend, 1972 was changed into their plain-vanilla list of big capitalization industrials which held their own 50 years ago.
So… The present pie-chart configuration followed by big household names in money management probably hold a losing hand for at least several years. Interest rates rest too low, bound to elevate seriously next few years. Rising interest rates do compress price-earnings ratios lower for the S&P 500 Index, below 15 times earnings.
In summary, conservative managers with tens of trillions in managed assets stand mired in this 60/40 matrix so likely to disappoint.
Morgan’s Top Holdings, 1972
Company Price-Earnings Premium Over
Ratio Market Index
IBM 37.4 100%
Eastman Kodak 48.2 165%
Avon Products 65.1 253%
Sears, Roebuck 29.5 60%
Xerox 48.9 166%
Procter & Gamble 32.0 73%
Walt Disney 81.5 343%
Polaroid 90.7 393%
Schlumberger 57.2 211%
In 1973, I remember the head of investments at JPMorgan commenting on his portfolio’s plight: “Geez! We should have seen it coming.” He was talking about the 1973 - ‘74 recession. The financial world then embraced an enclave of sober, dark suited Harvard MBAs who believed in America 365 days of the year. In the sixties, when growthies sold at 60 times earnings, the Street called it the “scarcity value” premium. Not enough of ‘em to go around. I’d stay sensitive to bull market rationalization patter. Very dangerous.
What to do when the shoe’s on the wrong foot, when they’re trashing everything in sight? Disbelief in growth surfaced in 2013 – ‘14. Legit growth properties sold at little to no premium over the market. Why so many bargains then? There was a sound fundamental reason for disbelief. Gross margins for technology houses traced a downward slope. Yearend, 2014, The market sold at 12 times earnings, a good working valuation for a turnaround in earnings.
Aside from internet properties and biotech houses, the Street’s analysts then turned their backs on the golden oldies like Microsoft and Coca-Cola. This was a big mistake, particularly, Microsoft, which continues to renew itself, year after year.
It’s difficult to sharp pencil internet houses like Facebook and e-commerce operators like Amazon. You can’t just employ the metric of earnings per share, alone. Amazon, for example, opens all quarterly reports with a different metric, namely operating cash flow for trailing 12 months. This gets followed up with their free cash flow metric, with year ago comparisons. Such numbers at least tell you about the company’s wherewithal to broaden its footprints and undertake new initiatives. For example, Amazon’s cloud computer business was a start-up built into a major operator, comparable with Microsoft.
Nobody owns Amazon for its net income next 12 months, but, rather earnings capacity 3 years ahead. This is what growthmanship is all about. I’m a holder, but Amazon is a luxury. I’ve as much capital in Alcoa, a value play in a zippy economic setting.
Yearend, 1972, growth stocks peaked at 2.7 times the market’s valuation. Each succeeding cycle witnessed declining relative prices for growth until the late nineties. Summer of ‘93, growth bottomed near parity with the market index, a 15-year low.
My oversimplification: Never, ever pay more than 2 times the market for a prime growthie. And, at the initial whiff of fish, bang it out. Today, absent a zippy economic setting, the market is easily 10% overvalued.