One of my guilty pleasures is watching the Starz series Spartacus. As a history buff, I am well aware that the producers take sweeping liberties with the historical facts surrounding the slave rebellion, but I’m ok with that. It’s great entertainment.
But even as you cheer for Spartacus as his band of escaped gladiators bests the hapless Romans in episode after episode, you know that the story won’t end well. The historical Spartacus didn’t topple the Roman Republic, nor did he liberate all of its slaves. Though he enjoyed a good run, his rebellion was eventually put down by a professional army led by Crassus, and he was either killed in battle or lived the rest of his life on the run. His body was never found.
Though the “blood and gore” in the capital markets are rhetorical and not literal as it is in the gladiatorial arena, the investment game is a spectator sport that can also turn your stomach at times. In watching the moves of your fellow investors, you often instinctively know that certain trades are doomed to end very, very badly. Whether it is Miami condos in 2005 or fly-by-night dot com stocks in 1999, you know that the investors buying in the late stages of a bull market are setting themselves up to be slaughtered when the market, like a Roman emperor deciding the fate of a defeated gladiator, gives the investment a thumbs down.
So, with that said, where might the greatest risks be today?
In my view, the riskiest major asset classes are U.S. Treasuries and the Japanese yen.
Far from offering a “risk-free return” as financial theory would suggest, U.S. Treasuries now offer plenty of risk and virtually no return. At time of writing, the 10-year Treasury note yields a pitiful 2.19%. Even in a low-inflation environment (which I forecast), this is almost guaranteed to give you a negative real return over the life of the bond. And if yields rise to a level I consider appropriate for this macro environment (say, 3.0-3.3%), investors would be looking at capital losses of roughly 10% on their “risk-free” bonds. It is little wonder that Warren Buffett commented that bonds priced at current levels should come with warning labels on them.
Similarly, the Japanese yen is a ticking time bomb. The yen’s strength in recent years has been due primarily to two factors:
- Investors had a preference for anything that wasn’t related to Europe.
- The yen’s appeal as a funding currency for the carry trade was reduced by the low yields on offer in the United States and elsewhere and by a general industry-wide move to deleverage.
Japan has debts that it simply does not have the ability to repay. When Japanese market interest rates begin to rise—and when Japan is forced to turn to the international bond markets, they most assuredly will—the only way out will be through a hyperinflationary devaluation of the yen. For investors accustomed to seeing deflation coming out of Japan, this will come as a bit of a shock (see “Japan Train Wreck Accelerating” for a longer explanation).
Interestingly, the objects of the last two bubbles—tech stocks and single-family homes—appear quite attractive at current prices. I recently penned an article in MarketWatch singing the praises of rental houses as an investment for the next decade (see “Here’s the Catalyst for a Housing Rebound”), and I have also added a position to large-cap technology stocks in my Covestor Tactical ETF model. Similarly, I continue to see value in the epicenter of last year’s turbulence, Europe.
But for the core on a long-term portfolio, I continue to recommend dividend-paying stocks. At current prices and given the yields on offer by competition in the fixed-income market, dividend-paying stocks would appear to offer the best risk/return tradeoff for the remainder of the decade.
Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. Sign up for a FREE copy of his new special report: “Top 3 ETFs for Dividend-Hungry Investors”