Older investor - protect yourself with TIPS

Investment Analysis Clubs Macro Economic Trends and Risks
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I’m not the only risk-averse older investor who buys TIPS for protection.

https://www.wsj.com/finance/investing/what-you-should-do-about-the-stock-markets-giant-problem-f4ca338e?mod=hp_lead_pos10

What You Should Do About the Stock Market’s Giant Problem

More than half the S&P 500’s return last year came from just seven companies. That’s a concern—but not for the reason that market commentators claim.

Jason Zweig

By Jason Zweig, The Wall Street Journal, Feb. 7, 2025

This week, the top 10 companies in the S&P 500 made up more than 37.5% of the index’s total market value…

What investors should worry about, though, is overvaluation. The S&P 500 is trading at about 22 times what analysts expect its constituent companies to earn over the next 12 months. That’s far above its average, since 1990, of 16.4 times expected earnings… Even after the stumble in tech stocks late last month, the Magnificent Seven traded this week at an average of 43.3 times what analysts expect them to earn over the next 12 months.

And with 10-year Treasurys yielding 4.4%, up sharply from last fall, the relative risk of stocks is higher than it has been in years…

If you’re in or near retirement, though, you no longer have decades of paychecks in front of you, and your human capital has lost its power as a hedge. [That is, a way to earn back the money that you lose during a stock market slump. – W]

Treasury inflation-protected securities, or TIPS, are an ideal way to cushion your wealth against the risk of a stock-market decline and the corrosive effects of inflation. I’ve bought them, and I think you should, too—now more than ever. [end quote]

For those who understand graphics …
The stock bubble…

TIPS yield near multi-decade high…

Wendy

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Yep. I bought some I-bonds nearly 30 years ago and they’ll be maturing over the next 2 -3 years. They’re the worst performing asset in my portfolio. (But then, so is my home insurance policy, and my health plan.)

It’s very expensive “insurance” vs. a buy & hold investment in the S&P 500.

The value of my I-bonds are a bit less than 3 times my purchase price

A 27 year investment in the S&P 500 with dividends invested is now worth about 9 times your initial balance.

I’ll leave it to the student to decipher which retiree sleeps better at night – the one drawing 4% from the bonds, or 1.3% from the stock portfolio.

And he’ll still be sleeping easy when he’s drawing 2.6% from the stock portfolio after a 50% market decline.

intercst

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It’s also instructive to note that this 27-year period INCLUDES the 99/00 downdraft, the 08-10 GFC, and the pandemic downdraft.

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You mean 4 times it is September 2025?

High risk. Don’t call it from the top of the market. A market that was only priced in premium values.

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Yep. That’s what people miss with all the market timing in response to “interest rates” and “stock market overvaluation”. Both 2000 and 2008 were 50% stock market declines. But if you ignored Hussman, you did just fine.

I read Wharton Finance Professor Jeremy Siegel’s book “Stocks for the Long Run” when it was published in 1994. I haven’t had a need for employment since.

Stocks for the Long Run - Wikipedia

intercst

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In another post when I talked about focusing on the real rates, I had TIPS in mind. Currently you can get TIPS with inflation with 2% to 2.5%, which is a great deal.

Separately, I am not sure the Mag7 multiple is correct, but set aside the valuation for a moment. The Mag7 will be able to exploit/ benefit from AI+inference+AGI+Robotics. The upside potential here is difficult to visualize now, but could be much higher than we expect, except, the government decides take it via taxation and regulation, which I doubt.

So, don’t let valuation, concentration arguments shake you from your legacy cost basis. You cannot compare railroad, manufacturing era 10% margin with technology margin, and thus the valuations or multiples are not comparable. The 20+ PE is normal and 16x is anomaly. For all those who are making markets are expensive, don’t realize if you remove tech, the rest of SP500 multiple is 17, hardly expensive. And tech/mag 7 earned their higher multiple.

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Does this advice still hold given Trump’s threat to violate his oath and default on the debt?

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Paraphrasing that…

Since he has been bankrupt repeatedly he wants you to experience that.

Further paraphrasing something he says, “It is not really bankruptcy if you are smart”.

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What do you estimate the ROI on AI/etc to be? Also what happens if smaller, more nimble, companies are able to use the AI/etc to better compete with the giants? Could it be that the giants get dethroned due to AI?

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Don’t be overly dramatic. There is a limit to his powers. Currently he is enjoying (or abusing) his honeymoon period. This too shall pass.

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But not a limit to his dragging his heels.

He is running everything up through the courts to the Supremes. He will lose but won’t pay or won’t pay on time.

To paraphrase what he says, “It is not bankruptcy if you are smart”.

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This is not a bug, but feature!!! Smaller nimble companies with cutting edge tech disrupting existing giants is a common feature. We should welcome that. It is one of my 5 year theme, i.e., software/ technology will eat the world again! Lot of SW companies will be able to develop new applications using AI. However, AWS, AZURE, GCP is where they will run!!! That includes even AI foundation models. It is not easy to replicate or dethrone META, GOOGLE touch, or monthly active user base.

Unlike the past giants, google’s of this world are investing heavily. Let us not forget the entire AI boom actually originated from Google labs, not in OpenAI labs. They will be fine, but keep your eyes open.

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I wonder if there can’t be some sort of comparison today on a different part of the story. The tech story went that tech with relatively minimal capex was able to scale up rapidly and grow revenue and profits at high margin. But that story seems to be changing somewhat. Maybe tech (at least the AI part of it) is becoming more like railroads in that lots of continuous capex is required? Look at the biggies, Alphabet investing $80B or so capex for AI, Microsoft similar, etc. But also look at the history - they each invested $10B for the 100-level AI tech, now $80B for the 200-level AI tech, all before ever seeing any real ROI on those investments. What happens if 300-level tech arrives, and what if it costs $150B, and what if not enough ROI was achieved before that happens? It’s like railroads having to lay a whole network of new track, AND having to maintain all the old tracks, and then once they hit the beginning of some ROI, suddenly they have to add new signaling mechanisms all across their networks! Then another 10 years go by, and they start making an actual profit, and BOOM, a huge government mandate comes for safer road crossings, and that wipes out the next 10 years of return. And then a recession comes, and volume is way down, and and and …

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This is not true. The internet era, the cloud era all required heavy investments upfront. If you look at $AMZN, the heavy investment they made in AWS had suppressed their profitability for a decade. It is not the investments, but the return that matters. AWS has 35%+ operating margin, compare that to your industrials where the margins are 10%.

Below is $AMZN capex

Year Capital Expenditures (in billions USD)
2015 9.9
2016 10.2
2017 13.2
2018 25.1
2019 23.5
2020 22.3
2021 24.6
2022 31.5
2023 32.3
2024 52.5

This is $GOOGL’s

Year Capital Expenditures (in billions USD)
2015 9.9
2016 10.2
2017 13.2
2018 25.1
2019 23.5
2020 22.3
2021 24.6
2022 31.5
2023 32.3
2024 52.5

Now the homework, is compare this capex with their FCF (free cash flow), that is the money that is left after making these cap-ex. The difference is industrial era required significant operating costs too, today tech companies have 80% gross margin, $NVDA which is a hardware company for its data center division sports 90% gross margin.

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Amazon FCF:

Year FCF (in billions USD)
2015 7.45
2016 10.47
2017 8.31
2018 19.4
2019 25.83
2020 31.02
2021 -9.07
2022 -11.57
2023 36.81
2024 38.2

So what do we see here? Has Amazon earned back their capex in free cash flow? NO, not even close. Even if you exclude all the negative cash flow years, they still don’t even come close. (Your numbers don’t look right to me, but I’ll take your word for it)

Google’s FCF has indeed proved to be resilient and excellent. But maybe that’s because Google is mostly an advertising company and only somewhat of a tech company? The question is - will that change with the massive AI capex planned?

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Sure

Everything is coming up roses.

Get rid of the interest carry loop hole and then what?

This used to be a supply-side era. Premium values.

That is coming to a crashing end.

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They planted Venus fly trap.

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Absolutely. If you want to look at the earnings of the investment made this year, then you should just look at the cash flow of the next year not FCF. Remember, $AMZN’s investments in capex are not maintenance cap-ex but growth cap-ex. So they have increasing capex. $AMZN build AWS a $100 B revenue runr ate company organically. Today $AMZN’s logistics business is bigger than $FDX and $UPS. Now, remember $AMZN had no logistics business in 2014. These business are build organically, so you should take into account when you look at the cash flow generation.

The best way to understand is in 2025 $AMZN cashflow will be $135, in a typical maintenance cap-ex scenario you are looking at over $100 B FCF.

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This is an old TMF Thread on $AMZN. It is a very long thread. I recommend a read. You would see lot of arguments similar to what you were making today.

Those who focused on “GAAP profitability today”, sat out trillion $$$ market cap runs. It is perfectly okay to say this is not for me. But accusing $AMZN has indulged in fraud etc… I understand it is very difficult to stay “open minded”, commitment bias is not easy to overcome, and it works both ways about things you own and things you don’t own.

Every time I find myself asking am I being open-minded, I read this great quote from Bruce Lee.

“Be like water making its way through cracks. Do not be assertive, but adjust to the object, and you shall find a way around or through it. If nothing within you stays rigid, outward things will disclose themselves.

Empty your mind, be formless. Shapeless, like water. If you put water into a cup, it becomes the cup. You put water into a bottle and it becomes the bottle. You put it in a teapot, it becomes the teapot. Now, water can flow or it can crash. Be water, my friend.”

― Bruce Lee