Investing

You may not realize it yet, but you desperately need to diversify into tangible assets.

I know, I know.  Why in the world would any investor want to diversify out of conventional assets?  After all, the S&P 500 Index skyrocketed by 31.49% in 2019 while the S&P U.S. Treasury Bond Current 30-Year Index returned a robust 15.74% during that same period.

Stocks have offered investors another major benefit beyond just strong returns, though.  They have also enjoyed good liquidity, with the ability to quickly buy or sell large blocks of shares at tight bid-ask spreads.

However, there are very good reasons to believe that these advantages for conventional assets might soon reverse.

For example, high returns over the past several years have been a product of ever rising valuations.  Corporate earnings and revenues have both lagged badly during this time.  We can see this via broad market valuation tools.

One of my favorite valuation methods is the price-to-sales ratio, which measures a company’s market cap versus its gross revenue.  Revenue, synonymous with sales, is generally superior in valuation calculations because it is less volatile and more resistant to accounting fraud than earnings.  As recently as late February 2020, the price-to-sales ratio of the S&P 500 sat at 2.43 – far above its long-term average of 1.0 and even higher than it was during the 2000 Dot Com bubble peak.

S&P 500 Price to Sales Ratio – February 2020

The market-cap-to-GDP ratio is my other preferred valuation indicator.  This measurement tool compares the broad Wilshire 5000 Index against U.S. GDP.  Market-cap-to-GDP is so reliable that it is a favorite of investing icon Warren Buffet in determining how expensive the overall equity market is.  Sadly, this valuation gauge was also signaling extreme overvaluation in late February at 158% versus a more reasonable long-term average of about 75%.

Market Cap to GDP – February 2020

Even traditionally safe bonds are a bad deal right now.  Due to the massive rally in credit markets during 2019 and early 2020, long-term bond yields are at all time lows.  The 30-year U.S. Treasury bond has a paltry yield-to-maturity of less than 2.00% per annum.  If you purchase one of these securities and hold it for the next 30 years, this abysmally-low single-digit return is without a doubt exactly what you will receive!  Corporate bond spreads over treasuries are also compressed, closing off yet another potential avenue of escape.

And if there should ever be a future financial crisis – even a minor one – you can rest assured that the abundant liquidity that markets offer today will instantly disappear, evaporating like water in a scorched desert.  It is probable that many small cap equities, junk bonds and ETFs will become dramatically illiquid in such a scenario, thus thwarting any attempt by panicked investors to exit those positions.

So while a conventional 60%-40% portfolio balanced between an S&P 500 Index fund and a bond fund may have worked well in the past, it sure won’t in the future.  These paper assets are simply not going to give you the safety of principal and returns you need in order to preserve, much less build, your wealth.

But wait, it gets worse!

Beyond the massive overvaluation and false liquidity present in most markets, there is another critical flaw inherent to conventional assets that your financial advisor or stock broker has been all too happy to ignore.  The supply of most financial assets isn’t limited by any realistic physical restriction.  Instead, paper assets like stock and bonds can be effectively manufactured in almost any quantity desired.

Want proof?

As our decade-long equity bull market has boosted demand for stocks, Wall Street has responded by fabricating securities to sell to a gullible public.

Within the past year a whole host of companies with no profits and questionable business models have been taken public.  For example, Wall Street unceremoniously rushed ride-sharing service Uber out the door in March 2019 (UBER: IPO price $45; current price $33.87) at the low end of its range when it became apparent that the market was starting to sour on its money-losing twin, Lyft.

A near carbon copy of that debacle occurred more recently in February 2020 when investment banks IPO’d mattress maker/retailer Casper (CSPR: IPO price $12; current price $9.02) at an underwhelming valuation, leaving some of its earlier private equity investors underwater.

But perhaps the most notorious instance of stocks being made like sausage belongs to short-term office rental company, WeWork.  The Wall Street clown show heroically tried, but ultimately failed, to shove this corporate fiasco down the market’s throat in August 2019.  Much to the underwriters’ chagrin, there simply weren’t enough suckers willing to buy the lie.

As an aside, what sort of dumpster fire did WeWork have to be for its IPO to fizzle during the height of one of the biggest stock market bubbles in human history?

But what I find truly frightening about modern finance is its eerie parallels to medieval alchemy.  In the 16th and 17th centuries, many otherwise intelligent men wholeheartedly believed that they could turn lead into gold with the power of science.  And while we now know that transmutation is technically possible (albeit uneconomic) via complex and energy-intensive nuclear fission, medieval alchemists came nowhere close to achieving this feat.

Likewise, today we have countless PHDs, MBAs and CFAs who assure us they’ve discovered the path to perpetual prosperity – usually via some ill-conceived unicorn tech IPO.  Never mind that the company in question will most likely never turn a profit.  Or that its market segment has few or no barriers to entry.  Or that other established incumbents are preparing to spend it under the table.

And if you’re too smart to fall for their claims of lead-into-gold equity riches, they’ll happily try to con you into buying a “safe” ABS subprime auto loan with a juicy 6% coupon that sounds great…until you learn that the default rate is 23% (and rising)!

Contrary to what the Wall Street charlatans want you to believe, true wealth can’t be conjured into existence by a few computer keystrokes.  Every time humanity has tried it in the past, the results have been absolutely disastrous – financial panics, depressions, market crashes or worse.

So what is an investor to do?

The answer is remarkably clear.  First, we must acknowledge that wealth – real wealth – is difficult and labor-intensive to create.  It is rare and consequently precious.  If enduring wealth could really be casually printed up on a certificate or electronically credited to a balance sheet, humanity would have figured it out long ago.

Instead, we discovered that although hope might spring eternal, a sucker is still born every minute.  Even though we know it’s a lie, we still all too often chase the dream of wealth rather than the reality of wealth.

Charles Mackay, the author of that seminal mid-19th century book on financial bubbles, Extraordinary Popular Delusions and the Madness of Crowds, once said that “Men…go mad in herds, while they only recover their senses slowly, and one by one.”

I sincerely hope that you, dear reader, are one of those individuals who regains their senses right now, while there is still time to protect yourself.

And there is no better way to sidestep the Wall Street casino than by investing in tangible assets.  I’m talking about things like classic cars, vintage wine, fine art and antiques.  These are the asset classes that have been neglected and forgotten while the bubble-crazed U.S. equity indices have shot to the moon.

But the best reason to own tangible assets is because they represent real wealth.

For instance, Trellis Wine Investments estimates that less than 1% of the global wine market can be considered investment grade.  And the grapes that go into those exceptional wines must be picked, transported, crushed, fermented, bottled and aged.  All of these steps are real, physical processes that require land, equipment, manpower, knowledge and time.

And if you happen to drink that superb bottle of wine, it is impossible to get more without engaging in real work.  You can’t simply print a new bottle of 1982 Lafite when you want more.

In addition, as you can see from the 10-year chart below, there is very little correlation between investment grade red Burgundy and Bordeaux wines and the S&P 500 Index.  Indeed, we could go so far as to say that the two asset classes are inversely correlated at key points of equity turmoil.

The situation is the same with antiques.

For example, high-end vintage mechanical wristwatches from the 1940s, 1950s and 1960s were never produced in large quantities.  They were expensive luxury items that only the well-to-do could afford.  Later, in the 1970s and 1980s, many were lost as the rising price of gold and advent of reliable quartz watches prompted people to scrap their old watches.

As a consequence, an original vintage Jaeger-LeCoultre Memovox, Breitling Navitimer or Audemars Piguet Extra-Flat is incredibly rare today.  But surprisingly few people have figured out this investing secret yet.  So you can still buy one of these beauties for just a few thousand dollars, even though prices should realistically be two or three times higher in a sane world.

And of course, the world will never get anymore vintage luxury watches.  Whatever is out there today is all the supply there will ever be.  Much like fine wine, vintage watches can’t simply be printed on demand by the Wall Street money machine.

As an added bonus, the prices of vintage wristwatches are similar to investment grade wine in that they aren’t correlated to broader market movements.  For instance, the below chart shows the auction performance of a model of vintage Patek Philippe Calatrava watches since 2006 (ref. 2406; the pictured 1940s specimen is pink gold, which was quite popular in the post World War II era).  Notice how prices for these classic timepieces barely dipped when the 2008 Great Recession hit and have subsequently trended steadily upwards.

What’s the upshot of all this?

You need to be invested in tangible assets.  I don’t care if it’s only 5% or 10% of your portfolio as an insurance policy/hedge position.  You need to have exposure to them.  They are the antithesis of the Wall Street sausage factory.  The fact that tangible assets are criminally undervalued in today’s all-equities-all-the-time world is just icing on the cake.

We live at a unique junction in financial history – a time when antiques as an asset class are the cheapest they’ve been in decades, if not centuries.

Want an example?

How about diamonds?  These gemstones par excellence have been known as symbols of love and wealth since medieval times.  And although I’m not a big fan of investing in modern white diamonds, I do love their antique cousins: old mine cut and old European cut diamonds.

Before the discovery of major deposits in South Africa around 1870, diamonds were one of the world’s rarest gems.  In fact, only the very wealthiest people in the noble or merchant class could afford to own a diamond (even a fairly small one) in the pre-1870 era.

But fast forward to today, where $15,000 is enough to buy you a gigantic old mine cut diamond weighing between 2 and 4 carats.  This is the kind of stone only the richest of the rich would have been able to afford in days past.  Sure, $15,000 isn’t particularly cheap on an absolute basis, but at only 1/4 to 2/5 of the typical annual salary of a U.S. middle class worker, a sizable old mine cut diamond is still far more approachable than at any previous time in human history.

Today’s antique bargains aren’t limited to old diamond jewelry though.

Discerning collectors can currently buy a complete antique sterling silver service for 12 people (consisting of 60 to 90 individual pieces) for between $2,000 and $3,000 – generally less than a month’s gross wage.  Contrast this with the $400 to $600 price tag of a similar service purchased new in the late 1930s.  Of course, the average American wage at that time was just $1,368 a year, meaning that a complete silverware set cost more than 4 full months of labor.

But I’m particularly fond of 19th century French silverware sets.  The French had (and still do have, to be honest) an artistic flair that makes their old silver one of the great antique bargains of the modern era.  It is possible to pick up a set of elegantly-wrought Belle Époque solid silver teaspoons for just a few hundred dollars (and sometimes less).  As an added bonus, some of these sets are fire gilt – a silversmithing technique that was abandoned in the mid 19th century for inferior (but cheaper) gold electroplating.

This pricing is insanity.

In some instances, you are paying as little as double melt value.  I’m not sure how much French silverware cost in the 1830s or 1860s or 1880s, but I’m absolutely certain that it sold for far, far more than double melt value.

It is difficult to convey in words how anomalous the situation in the antiques market is right now.  Average people have the ability to afford objects that would have only been accessible to dukes and duchesses in past ages.  And although I’ve only given a couple examples above, the situation is similar across a broad swath of the antiques industry.

But how did this happen?  How did unrivaled antique bargains become a seemingly ordinary fixture of the modern world?

I think that we can safely lay the blame for these stunningly low valuations on the onerous economic backdrop of the last 20 years.  The average household has taken on more and more debt in order to maintain their lifestyle in the face of stagnant wages and ever rising costs.  This excessive debt has gradually choked consumer demand as people have prioritized the mortgage payment and grocery bill above all else.

Things came to a head during the Great Recession of 2008-2009 when many households simply collapsed financially.  The U.S. Federal Reserve boldly rode to the rescue, but only for the banking system.  Our monetary authorities effectively printed money and handed it out to their banking buddies, while leaving average Americans desperate for even the smallest of financial crumbs.

Under these circumstances, it becomes easier to see how such beautiful and desirable antiques came to be esteemed so shabbily.  In effect, we have been experiencing a soft depression where all the usual economic indicators – the stock market, unemployment rate and GDP – are solidly green.  But this obscures the true financial condition of the average household, which is poor – bordering on insolvent.

In reality, the present economy is much closer to that of the 1930s – the era of the Great Depression – than it is to some bold new 21st century economy.

So what’s the takeaway here?  It’s pretty simple.  Antique bargains abound today – fine vintage items are simply dirt cheap no matter which valuation methodology you choose to use.  The only items that have been bid up these days are one-of-a-kind trophy antiques or artworks – the kind of things that billionaires display in the cavernous foyers of their $100 million beachfront homes in order to impress other billionaires.

This leaves us with some good news and some bad news.

Here’s the good news first.  If you’re looking to buy vintage items at more realistic prices – say anything less than about $100,000 – then you’re in luck.  Antique bargains can be found in everything from old furniture to vintage jewelry to 20th century Japanese woodblock prints.  The only caveat I would give is to bias your purchases towards pieces that meet the Antique Sage’s 5 rules for investment grade art and antiques.

Now for the bad news.

It is almost a foregone conclusion that a recession is coming.  And given the frailness of the world’s ailing financial system, it is likely to be global in nature.  This will mean mass layoffs, falling stock markets and widespread corporate bankruptcies.

The time to prepare for this outcome is right now.  Sell some of the stocks in your retirement or brokerage account.  Make sure that you have sizable cash reserves.  Don’t take on frivolous or unnecessary debts.

Antique prices have a tendency to stagnate or fall during recessions.  This makes it an ideal time to buy.  But you can only take advantage of the fire sale pricing if you have some free cash when the time comes.

I believe that the coming recession will be so severe that the Federal Reserve (and most other central banks around the world) will eventually resort to dropping helicopter money on the public in an attempt to improve the dire economic situation.  But the period leading up to this unconventional monetary policy will be absolutely brutal for most people.  Only those with their financial houses in order going into the crisis will be well-positioned to take advantage of the tumultuous situation.  There will be tremendous antique bargains to be had, but only for those who are prepared.

Read more thought-provoking Antique Sage investing articles here.

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Read in-depth Antique Sage investment guides here.

There’s an old financial saying that you can’t time the market.  And while I’ve found this dictum to be largely accurate, it does ignore one almost surefire way that investors can boost their investment results over the long haul.

I’m referring to allocating your portfolio based on broad valuation metrics.  If you overweight asset classes that are undervalued while shunning those with overvalued, you simply can’t help but make money over long periods of time.

Perhaps the best way to do this is by forecasting real returns for asset classes.  The word “real” in this context means returns that have been adjusted for inflation.  For example, if you expect inflation to run at 2% per annum but your bond has a yield-to-maturity of 5%, then your real return is the difference between the two: 3%.

Now that 2020 is here, I thought it would be interesting to examine the major asset classes and project their real returns over the next decade.

The results are surprising, but not in a good way.  Despite the 2019 stock market melt-up, investors in conventional assets have a whole lot of nothing to look forward to over the next 10 years.

You can see this for yourself in the chart at the top of this article.  It details my personal return projections across 6 popular asset classes between 2020 and 2030.  These assets are: stocks, real estate, cash, corporate bonds, U.S. Treasury bonds and TIPS (U.S. Treasury inflation-protected bonds).

As an aside, my projections for stocks and real estate are based on a formula provided by the money manager John Hussman, founder of the Hussman Funds.  You can read more about his methodology in an article I wrote back in 2017.

Now onto the crux of this article – the implications of my projected 2020s investment real returns.

First up are stocks, which are represented by the S&P 500 Index.  The picture here is not pretty.  According to my calculations, stocks are likely to decline by -3.38% in real terms every year during the 2020s.  Ouch!

Of course, this estimate is just that – an estimate.  If inflation or nominal GDP growth is different than my forecast (2.0% and 4.0% per annum, respectively), then the outcome will be different as well.

But the really big question mark regarding stocks is the multiple they trade at.  At the end of 2019, the S&P 500 surpassed its highest price-to-sales multiple ever.  Yes, higher than even the 1929 stock market peak or the 2000 Dot Com bubble.

Right now the index trades at 2.35 times sales, versus a more normal ratio of 1.0.  In fact, if you discount the last 20 year period of market history (which has just been one long asset bubble train wreck), the average price-to-sales ratio is closer to 0.8.  So I’m being quite generous by spotting the market a 1.0 multiple here.

In case you’re wondering, I use price-to-sales rather than price-to-earnings because earnings are much more volatile and easy to manipulate compared to revenue.  And honestly, most other valid valuation measurements will give you similar results anyway, including price-to-tangible-book-value, Tobin’s Q ratio or market cap-to-GDP.

That last ratio, market cap-to-GDP is an interesting case.  This valuation metric, which is favored by Warren Buffett, indicates that stocks (as represented by the Wilshire 5000 Index) will decline by a nominal 2.8% per annum over the coming years.  Once you subtract the expected 2% inflation rate from this number, you end up with a dreadful -4.8% real return.  This is actually worse than my already rather pessimistic stock market projections using the price-to-sales ratio!

Real estate is no safe haven either.  I’ve averaged the valuations of two best-in-class REITs to represent this asset class: Reality Income Corp. (ticker “O”) and National Retail Properties (ticker “NNN”).  According to my projections, real returns for REITs are likely to be an abysmal -3.25% per year in the new decade.  This is almost as bad as stocks.

I do realize that real estate is a very diverse asset class and that a couple REITs, regardless of how well chosen, can’t possibly represent every niche.  So if you happen to own rental properties far from the overpriced U.S. coastal markets that are cash-flowing nicely, then you might very well be justified in ignoring my real estate return forecast.  Just don’t expect to buy a convenient REIT security in your IRA or 401-k account and walk away with positive real returns after inflation.

The situation improves a bit with cash.  This asset class should return an uninspiring -0.43% per annum after inflation through the 2020s.  And although real returns on cash might be better than what you’ll get in stocks or real estate, they still aren’t positive.

The real return on cash is derived from the 3-month Treasury bill interest rate (1.57%) minus the assumed future rate of inflation (2.0%).  Of course, that assessment relies on 3-month Treasury bill rates staying where they are right now.  And that, in turn, is a function of what the Federal Reserve decides to do with interest rates.  And the open secret there is that the Fed will only drop short-term interest rates in the future.

So that nice safe -0.43% annualized real return actually has downside risk!  Of course, cash is nice because it can allow you to pick up investment bargains on the cheap later.  But you’ll bleed purchasing power little by little until that day finally arrives.

Next up is corporate bonds, which are represented by the S&P 500 Bond Index.  This is a fixed-income index composed of over 5,400 securities issued exclusively by S&P 500 companies.  Right now the yield-to-maturity on this index is 2.87%.  Subtract inflation from this and you end up with 0.87%.

But that isn’t the end of the story.  You also have to account for default risk.

Unfortunately, corporate America has levered itself to the moon since the last financial crisis, increasing its aggregate debt load from $6.3 trillion in 2007 to $10.1 trillion in 2019.  As a result, default risks have increased dramatically (although you wouldn’t know it from watching CNBC).

Photo Credit: FRED

In light of these facts, I applied a rather modest 1.1% default rate to the S&P 500 Bond Index, bringing the expected real returns on corporate debt down to -0.23% per annum.  In other words, corporate bonds will probably lose you money over the next decade after accounting for inflation.

The next stop on our whirlwind tour of future asset class returns is treasury securities.  These ultra-safe bonds are backed by the full faith and credit of the U.S. Government.

However, because they are ultra-safe, you can’t expect to get rich from them.  This is reflected in their real returns, which are currently negative.  The 10-year Treasury Note trades with a yield-to-maturity of 1.88%, giving a paltry annualized real return of -0.12% over the next 10 years.  This is not the stuff that investor’s dreams are made of.

The last asset class I wanted to examine is TIPS, or Treasury Inflation-Protected Securities.  These are U.S. Government securities that earn a guaranteed real return that is then adjusted (upward) for inflation.  That means that if you hold a TIPS bond until maturity, you will always get a positive real return (assuming its real interest rate was above zero when you purchased it).

TIPS is the only asset class that currently has a positive real return, making it unique among conventional paper assets.  Of course, the 10-year TIPS note is only priced to yield 0.15%.  But hey, at least it’s positive!

Investment returns this low are just depressing; they make building wealth almost impossible.

But there is an alternative for the sophisticated investor: tangible assets.  I’m talking about things like gold and silver bullion, antiques, gemstones and fine art.  These are the assets that have been ignored in our crazy, over-the-top “Everything Bubble”.

Now I can’t accurately predict the future returns of tangible assets with any degree of precision, which is why I haven’t included them in the chart above.  Antiques and other tangibles are difficult to value because they don’t have cashflows like stocks (dividends) or bonds (interest payments).  So you can’t apply traditional valuation metrics, like discounted cashflow analysis or net present value calculations.  This is, incidentally, one of the reasons that Wall Street tends to ignore this asset class.

But I can tell you that antiques, gold, fine art, silver and gemstones are all ridiculously undervalued right now.  They have simply been forgotten in our collective rush to find the next Amazon, Uber or Google.  In addition, tangible assets have no risk of default – an investment attribute that will become increasingly attractive once our current securities market mania collapses in tears.

So while I don’t know exactly what the real returns on antiques and other tangibles might be in the 2020s, I can confidently say that they’ll easily beat all of the 6 conventional asset classes that I’ve outlined in this article.  A nominal return of 4% or 5% per annum should be easily achievable.  This translates into real returns that are at least 500 basis points higher than anything the stock market casino can muster and a full 200 to 300 basis points better than bonds of even the highest credit quality.

Investors who want to play it safe can buy gold and silver bullion.  Those who are more adventurous can load up on antiques like vintage Must de Cartier wristwatches, World War II era U.S. military insignia or Japanese Edo era samurai sword fittings.  The sky is the limit for the savvy connoisseur.

Just don’t keep your money in conventional paper assets thinking that it will make you rich.

Read more thought-provoking Antique Sage investing articles here.

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Read in-depth Antique Sage investment guides here.