TINA--The Greater Fool Theory In Disguise

 As you who have been reading my posts know ad nausea,  I believe that fair value for the stock market (the Standard and Poor's 500 Index) is the discounted cash flow of future dividends.  The discount rate is a function of the ten-year U.S. Treasury note.  I believe that both the stock and bond markets ultimately revert to historical norms.   The key factors--discount rate, earnings, and earnings growth rate--each undergo this mean reversion.

Now, at 2108,  the stock market is 67% overvalued according to Shiller's CAPE ratio.  The latest argument to justify more upside is best described as TINA, an acronym for "There Is No Alternative!".   After the yield to maturity of the ten-year Treasury bottomed below 1.5% in 2012,  it has been bouncing around 2% for many months.  Not much annual return over ten years.  But if you plug  a 2% discount rate into the stock market model, the fair value of the stock market is much higher than currently. So, given the assumption of a prolonged period of a much lower than normal 2% note yield, between stocks and bonds, there is presently no alternative but stocks--hence TINA.  

However, once the Fed accomplishes its goal of raising the inflation rate to 2.0%, the ten-year yield should ultimately reach 4% to 5%--its norm.  At that time, the stock market should approach fair value.
If mean reversion occurred immediately, the stock market would drop 40%; and the ten-year note 21%.

So if this happens soon, neither bonds nor stocks would be an alternative.  However, there is a third alternative--CASH (or cash equivalents).  I have been espousing building up a cash position  by rebalancing the stock portfolio as the stock market becomes more overvalued.  (I am awaiting a 70% overvaluation for my next rebalancing effort.)  I have also suggested selling some long-duration bonds and either keeping the proceeds in cash or other short-duration assets.

Why does Wall Street tend to underplay CASH as an alternative?--1) I have mentioned before that Wall Street is bullishly biased.  The industry makes much more money in a bull market than a bear.  And most of the time, the stock market rises.  If one makes a bullish bet and loses, he will not be alone; most of Wall Street will have also lost; so whatever accounts you lose, you will pick up accounts from others.  However, if you are bearish and lose, it can be very lonely; and net money under management will likely diminish. 2) If most major asset management firms decided, say, to reduce their equity exposure by ten percentage points, that act in itself would precipitate a bear market--too many money managers exiting at once. 3) Most financial asset managers charge a percentage of assets as their compensation.  If the client realizes that a portion of his assets is in cash, he might ask "Why am I paying you anything on the cash position?"4) High long-term capital gains tax rates, e.g., 31%  in New York State, are a serious disincentive to selling equities in taxable accounts.

By ignoring cash as a viable asset class,  those promoting TINA are engaged in "The Greater Fool Theory". That is, one fool believes  he can buy an overpriced asset and sell it at a more overpriced level to a greater fool. Trading between stocks and bonds only is like trading one overpriced  $10,000 dog for two overpriced $5,000 cats.

On another subject, I have placed our property of 21 years on the market at a "full" price, which represents a point of indifference between holding and selling.  I have been lucky with this investment, as have most who bought real estate at reasonable prices more than two decades ago.  As discussed in previous posts,  pricing at this particular location has a very high Wall Street influence.   So while my financial assets are only 30% in equities, if you adjust for this Wall Street factor, my real exposure to a bear market is significantly greater than if the property's value were not so correlated with how Wall Street fares.  I dearly love the property, and the capital gains tax upon sale would be enormous.  However, I long ago learned through a family experience never to fall in love with a material object! Given my view of the world, selling is the prudent thing to do.