This reporter’s go-to source for divining the investment categories, from all around the globe, that promise the best future returns is a feature on the Research Affiliates website called Asset Allocation Interactive. Research Affiliates oversees $188 billion in investment strategies, chiefly for mutual funds and ETFs, and provides the methodologies for its RAFI funds offered by Invesco, Charles Schwab, Pimco, and State Street. The firm’s chair and founder, Rob Arnott, is the former editor of the Financial Analysts Journal, and enjoys great respect in academic circles; in fact, his shop is a magnet for top PhDs in finance. Most of all, the formula that Interactive deploys for positing the gains-to-come is basic, convincing, and rooted in bedrock market math. You might summarize its message as “when you’re buying at extremely rich prices, you’ll usually fare poorly in the years ahead, and vice versa.”
That’s a credo you’ll seldom hear from Wall Street, but it’s worth adopting as a North Star, especially in today’s near frenzy that drove the S&P to an all-time high on May 14—after gaining 22% in the past year on top of an already towering valuation.
Here’s the dynamic that’s heavily swaying the Asset Allocation Indicator: The big rise in yields has made dull but super-safe Treasuries—the 10-year just hit 4.7%—a lot more attractive while the boom in U.S. large caps has rendered the class as a whole an extremely poor buy. The contrast between the big loss of promise on the equity side and rise in fixed-income’s appeal is so jarring that Treasuries and even cash look like a better bet than the S&P 500 in general, not to mention the likes of the Mag 7.
Why big cap tech stocks come in dead last among all investment choices right now
Asset Allocation Interactive projects future returns over the next decade for around 40 asset categories. The immense range comprises everything from Global Corporates and U.S. High-Yield and TIPs on the bond side, and for stocks, separate growth and value portfolios in both developed countries and emerging markets, further winnowed into large and small caps, not to mention U.S. REITs and diversified holdings in Europe.
To calculate the expected yearly gains from stocks, the Interactive takes the current dividend yield plus predicted growth in EPS, and adjusts for a rise or fall in valuation—incorporating a reversion to the mean for the PE. Specifically, the formula projects that from today’s starting point, the multiple will fall or climb halfway back to its historic average over the next decade. By the way, this is a conservative take in today’s market, since the S&P PE is so far above its norm that a 50% drop would still leave it in elevated territory.
According to the Interactive, U.S. Large Caps will give you a paltry 3.2% yearly return from now through May of 2036. Adjusted for expected inflation of 2.6%, that’s a “real” advance of just 0.6%. The outlook’s even worse for U.S. Large Cap Growth. It’s destined to advance a measly 1.7% a year, trailing the CPI by almost 1 point! In fact, of all the more than three dozen classes on the Interactive, U.S. Large Cap Growth finishes last. By the way, it’s of course the Mag 7 that dominates that grouping, and effectively accounts for its doghouse position. Collectively, the tech high-flyers are sporting a humongous multiple of 38, and the Interactive template reckons those PEs are due for a tumble.
Here’s what’s so sobering, and so counter to the edge equities have held in virtually every other period, excluding a couple of crazy interludes. Not only Treasuries but “Cash” wallop the S&P 500 (U.S. Large Cap) and especially cream the market’s most vaunted zone, the Large Cap Growth ruled by the likes of Nvidia, Alphabet and Tesla. A portfolio of Intermediate Treasuries of maturities between 3 and 10 years would hand you 4.6% annually, and beat inflation by almost two points. Even going with “Cash” where you invest in 30-day commercial paper, would return 3.5% and exceed the cost-of-living by 0.7%.
Hence, Research Affiliates predicts Treasuries will get you almost three points more than Large Cap Growth (4.6% vs 1.7%) and buying Commercial paper will do better as well (3.5% to 1.7%). By the way, the Interactive shows plenty of places around world where returns should easily beat Treasuries or cash, including such undervalued, unheralded venues as Emerging Markets Value, Europe, and U.S. Small Cap. Tech has had an amazing run. But Research Affiliates’ compelling math shows that dull and safe might be a smarter choice in the years to come.
