- Stocks are melting down in early 2022 as historically lofty valuations start to crumble.
- Meb Faber, the co-founder of Cambria Investment Management, shares why US stocks are in trouble.
- Here are the three best places to hide out with the S&P 500 set to stagnate in the next decade.
Meb Faber isn’t trying to burst stocks’ bubble; he believes equities will implode all on their own.
The co-founder and CIO of Cambria Investment Management — which manages $1.2 billion of assets through a dozen exchange-traded funds — has some advice for investors about what to do when the massive US stock rally unwinds.
That bearish scenario may already be underway.
2022 has been a brutal year for major US market averages so far. In the year’s first three weeks, the S&P 500 is down 6.9%, the Dow Jones Industrial Average is off by 5%, and the tech-heavy Nasdaq Composite has corrected by 10.8%. The small-cap focused Russell 2000 has already retreated 10.2% this year and is 17.5% off its early November highs.
Those losses are a jarring departure from previous years, especially for new investors. The S&P 500 rose between 16% and 29% from 2019 through 2021 as earnings crushed expectations and the
unleashed record levels of
in response to the pandemic.
But the party in markets is ending as the Fed scales back its easy-money policy, Faber said.
“The opportunity set in the US is really poor,” Faber told Insider in a recent interview. “We believe that US
weighted stocks — so S&P — are one of the most expensive in history as well as one of the most expensive relative to the rest of the world, ever. And so our broad expectation is that US stocks will probably return 0% real over the next decade.”
That call for the S&P 500 to have no meaningful inflation-adjusted returns from now through 2032 puts Faber squarely in the contrarian camp. The 21-year market veteran believes investors are currently banking on annual returns of 17%, even though that’s nearly triple the 6% average annual return that large-cap US stocks have historically mustered.
Expensive US stocks may be in a bubble
Sky-high valuations are the main reason why US stocks will stagnate in the next decade, in Faber’s view. Using the cyclically adjusted price-to-earnings ratio (CAPE), which smooths out earnings over 10 years while adjusting for inflation, Faber found that in the 50 prior times that stocks ended the year with a CAPE over 40, they were in for a rough decade.
“Never once out of 50 years starting from this valuation level have stocks been even average,” Faber said. “So it’s a pretty poor starting point.”
The market’s CAPE ratio was over 40 at the end of last year — thanks to the sell-off over the last few weeks it’s currently hovering at just over 36.
Conventional wisdom argues that lofty stock valuations are justified because bond yields are in the cellar. After adjusting for inflation, government bonds globally have negative yields, which has led some investors to conclude that “there is no alternative” to stocks.
Faber strongly refuted that sentiment, both in a January 2021 blog post and in the interview with Insider.
“Stocks are allowed to be expensive because bond yields are low, right?” Faber said. “That’s not true. Historically, when bond yields are low, that is inherent with low valuations, like low teens. And we’re at 40 now. So it’s really just valuation/multiple expansion that pushed that.”
A recent tweet from Faber indicated that a doomsday scenario for US stocks — where multiples collapse by 40% to 70% — could be in play if investors gave the S&P 500 a CAPE ratio in the teens, as has happened historically.
I have no idea if inflation is here to stay.
Historically speaking, if it stays at these levels, investors have assigned stocks a much lower multiple.
Like 40-70% lower.
These are not my predictions, just the data.
— Meb Faber (@MebFaber) January 12, 2022
Where to invest if US stocks stagnate
Faber’s gloomy view of US stocks begs the question: Where can investors hide out instead?
There are three main ways to dodge the reckoning that may be coming for bloated US indices, in Faber’s mind: Invest in value stocks, foreign companies, and real assets.
Value stocks have run circles around their growth-oriented peers in early 2022 after lagging for most of the past decade, though both groups are down for the year. The S&P 500 Value index is down 1.9% this year, but is far better off than the S&P 500 Growth index, which has lost 9.6% so far.
Shares of companies with cheaper valuations are the place to be as the market rotation finally tilts in their favor, Faber said. The transition from pricey growth stocks to value names has built momentum since the market got news of 2020 election results and positive COVID-19 vaccine data two Novembers ago, Faber added. Now, the market’s message is hard to miss.
“The reality is, value is probably one of the best opportunities ever relative to market-cap weight in terms of our Shareholder Yield fund (SYLD),” Faber said. “For example, if you look at the underlying valuations it is just an enormous spread.”
Naturally, Faber is inclined toward his aforementioned fund, which is an exchange-traded fund that targets cheap quality and value names that return cash to shareholders through dividends and share buybacks. It avoids the “stupid expensive” stocks, in Faber’s words.
Alternatives to the Cambria Shareholder Yield ETF include the Vanguard Value
ETF (VTV) and the iShares MSCI USA Value Factor ETF (VLUE). Faber’s fund has topped those two competitors in the past one, two, and five years, but is lagging them so far in 2022.
Foreign stocks are also dirt-cheap and a “screaming” buy, Faber said, given that their CAPE ratio is in the low teens. Still, most American investors ignore overseas stocks, Faber said, adding that they make up just 20% of their portfolios on average — far from the 40% to 60% allocation he thinks they should have.
“This is the biggest opportunity for foreign stocks vs the US in 40 years,” Faber said. “The biggest difference was 40 years ago, foreign stocks were expensive and the US was really cheap. So it’s flipped.”
Cambria’s Emerging Shareholder Yield ETF (EYLD) is Faber’s way to play a long-awaited comeback in emerging market stocks, and provides a healthy 4.8% yield. Competing ETFs include the iShares International Select Dividend ETF (IDV) and the WisdomTree International High Dividend Fund (DTH), both of which yield 4.4%.
Adding exposure to real assets is another one of Faber’s favorite investing ideas, especially because he said he’s found that many investors don’t have exposure to assets like real estate investment trusts (REITs), Treasury Inflation-Protected Securities (TIPS), or commodities. The latter idea is one of few investments that’s a proven hedge against inflation.
“Commodities have been showing up in our Global Momentum ETF (GMOM) almost half of the past year,” Faber said. “Not precious metals yet, but add base metals, energy. If you have a sustained period of inflation, that’s important.”