What Market Bears Could Be Missing

Pure client: "Hey Nik, I've gone dark. Like deep down the rabbit hole. I'm super pessimistic on the stock market."

Me: "Why don't you try reading something positive?"

Pure client: "If you have something positive, I'll read it."

It's not my job to cheerlead, but our client needed a little balance in his life. As we have previously stated, finding negative market prognostications in 2020 is easy. Finding positive market commentary is much harder to find.

In my quest to find silver linings, I stumbled upon the most optimistic argument to be made for continued stock market prosperity that few are talking about. It started with a text from a friend...

"Watching a video on Real Vision with Jeffrey Gundlach. He's advocating for the Permanent Portfolio (25% cash/bills, 25% stocks, 25% bonds, 25% gold). Interesting."

FYI, Jeffrey Gundlach founded DoubleLine, a fixed income shop that rivals Pimco as the de facto bond kings. Mr. Gundlach was basically calling for a market blow up, not unusual for a bond manager, but noteworthy because he's a very smart investor.

A few days later, I read Howard Marks' latest memo, which I would encourage any curious investor to take on. This particular paragraph was seared into my brain...

Most decisions in investing are relative decisions. Investors try to find the most attractive opportunity so as to be able to achieve the highest risk-adjusted return. Thus a great deal of the selection process is comparative.

“I’m considering buying X. How does its risk/return proposition compare with the one on Y?”

Thus, assets and asset classes are inherently interconnected. Money moves from one asset class to the next in search of the best bargains, which get bought up until they’re at equilibrium with everything else.

In 2000, investors that grew weary of the froth in the NASDAQ tech index could clip ~6% in a "risk-free" 10-year Treasury bond. Certainly a reasonable trade for a risk averse investor.

Source: Ycharts

In 2007, leading up to the financial crisis, an investor seeking safety could still generate a positive return of 4-5% in the 10-year.

Source: Ycharts

You get where this is going. In October 2020, an investor skittish about (insert your own reason here), has a less than ideal opportunity set of safe assets (in fact, it's non-existent).

Source: Ycharts

Allocation decisions are not made in a vacuum. Rational investors are constantly evaluating the ever-changing opportunity set of available investments. In recent market pullbacks (2000 & 2008), investors had attractive risk-free alternatives to equities. In 2020, attractive opportunities to earn a risk-free real rate of return are nowhere to be found.

The most optimistic case for equities is the lack of a reasonable alternative or TINA (there is no alternative). Therefore, TINA is a tailwind that could carry equities higher (for longer than most expect) without an obvious reason.

This isn't a recommendation to load up on equities without a care in the world.

The underbelly of TINA is an exogenous shock, see COVID-19, can result in steep losses, panic selling, and collateral damage. Investors are poor at evaluating risk and range of potential negative outcomes. TINA doesn't make risk go away, rather risk is reclassified in a different form.

For further reading check out "Are Low Yields a Good Reason to Shun Bonds?"

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