The following is a guest post from FS sponsor, FarmTogether, a leading farm investing platform. Farmland investing is one way to reduce volatility in your portfolio and generate long-term passive income. Let's look more into investing in 2021.
2020 has been a turbulent year for investors to say the least. On February 19, 2020, the S&P 500 closed at a record high. The following day it began a steep descent, eventually bottoming out on March 23rd, as the COVID-19 pandemic began paralyzing the global economy. This decline officially ended the longest bull market on record.
Despite a strong recovery in the public markets since March 2020, the US economy is still struggling. With rising COVID-19 cases and uncertainty surrounding the outcome of the presidential election in November, investors have become more hesitant about taking risks.
It is more important than ever for investors to have a clear strategy for managing their portfolios in 2021. Let's first go over stock market volatility and valuations. Then we'll discuss three common investing strategies for managing uncertainty in 2021.
Investing In 2021: Volatility On The Horizon
Record-breaking stock prices have been coupled with record-breaking volatility. The CBOE Volatility Index (VIX), a closely watched industry measure of stock market volatility, hit an all-time high of 86.69 on March 16th as many parts of the country entered lock-down in response to COVID-19.
The VIX has been trending down, but is now creeping up again given there's still no second stimulus package and COVID-19 cases are once again surging. It seems likely that volatility will remain elevated as we head into 2021.
Is the Stock Market Overpriced?
The S&P 500 Shiller PE currently stands at about 30X versus a median Shiller PE of 16X. Therefore, from a historical standpoint, the stock market is overpriced. With so much uncertainty on the horizon, it is very hard to accurately predict future earnings.
For example, Bank of America's equity strategist, Savita Subramanian, raised her S&P 500 EPS estimate from $115 to $125, which would represent a 23% decline from 2019 levels. She then initiated a $155 2021 EPS estimate, which is still slightly below 2019 levels of $163.
If there is a viable vaccine introduced to the masses in 1H2021, Subramanian believes her 2021 EPS estimate has $5 upside. But even with a blue sky 2021 EPS estimate of $160, a 28% YoY rebound in earnings, the S&P 500 is still trading at 20X 1-year forward earnings, which is expensive compared to the median of about 15X.
In September, the Federal Reserve projected that the economy would shrink 3.7% by the end of the year. Some Wall Street economists predict GDP growth will rebound by more than 5% in 2021, but only time will tell. Investing in 2021 will require properly forecasting both corporate earnings and economic figures.
Why Are Valuations And Stock Prices So High?
Stock valuations are so high because earnings remain depressed. Investors are always forward-looking. Investors hope there will be government stimulus and a coronavirus vaccine in the near-term.
Additionally, the Fed’s decision to keep interest rates low for longer means that the stock market is one of the few places where investors can seek potentially higher returns given the opportunity cost is so low.
With that being said, the stock market is also currently overvalued according to the “Buffett Indicator,” which is at levels not seen since the dot com bubble in 2000.
The “Buffett Indicator” is calculated as the ratio of the combined market cap of a country’s publicly traded companies to the country’s GDP. Any value over 100% implies that the market is too hot. In August 2020, the Buffett Indicator reached an impressive 183%.
Bearishness From C-Level Executives
Economic metrics aside, many C-suite executives are also concerned that the stock market is too hot. According to an August survey by Deloitte, 84% of Fortune 500 CFOs believe that the stock market is overvalued, the second-highest level on record. Only 2% of CFOs believe that the stock market is undervalued.
Which such beliefs, it's hard to see publicly-traded companies resume stock buybacks once it's socially correct to do so. Stock buybacks have also been a catalyst for higher stock prices in the past.
Further, Deloitte’s survey also found that 60% of CFOs rated the US economy as “bad” or “very bad,” and only 43% expect better conditions in a year.
The presidential election in November adds additional uncertainty. It could take weeks to count all the mail-in ballots. Even after the counting is done, there might be a contested election that could be left up to the courts to decide. A contested election will likely lead to increased market volatility.
Perhaps there will be a Blue Wave or a Red Wave that will create much more certainty about economic policy in 2021 and beyond. With continued tremendous support from the Federal Reserve, 2021 could turn out to be a fantastic year.
No one can say for certain whether this level of volatility is the new normal.
Investing In 2021: Three Ways To Cope With Uncertainty
With all this uncertainty on the horizon, it is more important than ever for investors to be prepared for more vertigo-inducing stock dips. In order to protect wealth and continue to achieve long-term goals, we suggest three things.
1) Keep Diversified
Diversification is critical for building a portfolio that is resilient to market shocks. By adding multiple uncorrelated asset classes to your portfolio, you reduce losses in the event of a downturn in the stock market. Depending on the mix of investments, a diversified portfolio can also deliver above-market returns.
Diversification doesn’t need to stop at stocks or bonds – there are a number of alternative investments that offer benefits to investors. For example, farmland is a low-volatility asset class that is well-suited for long-term investors.
Over the past ten years, the value of farmland has risen over 6% each year. US farmland averaged 10% total annual returns from 1992 to 2018. Unlike some other alternative assets such as gold, farmland offers investors the benefit of passive income in the form of periodic cash dividends in addition to appreciation of the underlying asset.
2) Don't Try And Time The Market
With the stock market as heated and volatile as it is currently, it can be tempting for investors to try and wait for the “right” moment to invest. This is often a mistake. It is impossible to consistently time the right time to buy or sell.
While it’s clear now, that March 2020 was an excellent time to invest, hindsight is always 20/20. A good investor always has to try and forecast the future.
A better investing strategy is to dollar cost average. Invest sums at regular intervals instead of waiting to put all your money into the stock market at once. This is a natural way of ensuring that even when you’re buying high, you’re also able to take advantage of some of the market dips.
3) Maintain A Clear, Long-Term Strategy
The further you can stretch your investment goals, the easier it is to look past short-term volatility. Too many investors get spooked and sell when the market takes a downturn. This is a sure-fire way of losing money in the long run. Instead, the best approach is to understand your risk tolerance, allocate your portfolio in a risk-appropriate manner, and ride out the dips in the market.
Having a long-term plan helps take the emotion out of investing. And emotion is an investor's biggest enemy. By keeping your money in the market through the dips, you’re able to grow your savings with compounded interest.
Sam here. One of the tricks that has helped me stay the course is to think about investing for my children. In 20+ years, the long-term trend should smooth out and these short-term sell-offs will just be tiny blips.
Finally, remember that the market is more likely to go up than down. Over the past 40 years, markets ended up with positive returns ~75% of the time.
Consider Alternative Investments
If you dislike the day-to-day volatility of the stock market, consider investing in alternative investments like real estate, venture debt, private equity, and farmland.
Long-duration alternative assets like farmland have numerous benefits, including reducing overall portfolio volatility, mitigating risks, and providing passive income.
Thanks to FarmTogether for sharing their thoughts on managing uncertainty and thinking about the future. Personally, I've been slowly allocating more of my investable capital to alternative investments. I really dislike volatility, and would rather invest in a private investment that doesn't have a daily price update.
Ideally, my private investments generate a positive IRR over a number of years and surprise me with a nice balloon payment. Once you start regularly investing in long-term alternative investments, these surprises become much more regular.
One of the goals of having money is to be able to stop thinking about money. I want to live my life with minimal financial distraction. Investing in long-term alternative investments helps me achieve this goal.
My rough investment allocation is 40% real estate, 25% stocks, 20% bonds, 10% alternatives, and 5% risk-free. My goal is to increase alternatives to 15% and slightly reduce real estate to 35% in 2021 by growing my overall investment pie.
Stocks and bonds are expensive. Meanwhile, the return on cash is so low because interest rates have been slashed. Therefore, the most promising investment opportunity in 2021 is real estate or real estate alternative investments in my opinion.
Readers, what are some of your thoughts for investing in 2021? What type of opportunities do you see? How do you plan to position your investment portfolio? Is the stock market rally year-to-date setting us up for disappointment? Or do you think investments could really perform well in 2021?