You Need to Be Invested in Tangible Assets

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.

 

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%.

 

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.