Templeton's Rule for Expensive Markets

Steve, Tom and Jacob on a jittery world, a range bound ASX, where property falls might end, and the allocation chart we promised last week.

Five Things to Take From This Session

1. Conflict is spreading into infrastructure: refineries, data centres, undersea cables and even supermarket fridges.
2. France's borrowing costs are at their highest since 2002, and the eurozone has said it will not bail France out.
3. The ASX has gone nowhere this year. The conversation has moved to property, and nobody knows where the falls end.
4. The most common allocation mistake we see is over-allocation: staying fully invested because the market "has further to run".
5. On Templeton's rule, today's US valuations would justify no US stocks at all. That is why we look for the markets that are still cheap.

I. Geopolitics

Be alert and alarmed. Steve's view is that we are closer to a world war than most people appreciate, and he does not think that is an exaggeration. Here is what shaped that view this week.

Trump and the midterms

Our read is that Trump is under real pressure as the midterms approach, and his diesel deal with Putin drew immediate objections from Kyiv. We think the Democrats look well placed to take the House and are competitive in the Senate. Interesting times ahead.

France and the bond market

Protests and unrest over budget cuts have spread across France, and bond markets have noticed. France's 10-year yield has pushed towards 5%, its highest since 2002, and the spread over German bonds is at levels last seen in the 2011 eurozone crisis. France carries public debt of around 119% of GDP, and because it no longer has its own currency it cannot simply print its way out. Eurozone finance ministers have made clear no one is coming to the rescue. Not a good place to be.

Read:France's bond yields hit 24-year high as eurozone rules out bailout Herald Corp, via Reuters →

The Middle East

The war rages on. The Houthis have claimed missile and drone strikes on Saudi Aramco facilities and airports since the truce collapsed in July, though the Saudi-led coalition disputes some of the claims. No surprises there, but we should also expect US-Iran hostilities to flare again. Iran has also been threatening to charge fees on the undersea internet cables that run under the Strait of Hormuz, with state-linked media hinting at damage if companies refuse to pay.

Read:Yemen's Houthis say they struck Saudi Aramco sites in Riyadh, Khurais Reuters via Zawya →

Russia and Germany

Germany's domestic intelligence chief says Russia is using almost every tool it has against Germany, including planned assassinations. NATO has signalled it will respond.

Read:German spy chief says Russia using virtually every tool, including planned assassinations Newsquawk →

Now do AI

Overnight on 11 to 12 October, hackers pushed the fridges and freezers at hundreds of French supermarkets up to 50 degrees, causing fires and wiping out stock. The refrigeration supplier said the affected units were running outdated firmware. Maybe having everything connected to the internet is not a great idea. Now do AI.

Read:Hackers heat French supermarket fridges, sparking fires and spoiling food SBS News →

We think that's enough for the week, don't you?

II. The Oz Economy

We cannot have a podcast without discussing the elephant in the room: Australian property prices. Among finance types it seems to be the only subject worth talking about, because the ASX has spent the year going nowhere. Traders would say range bound. Investors would say boring. The market remains around 5% below its 2026 high.

Property, on the other hand, has plenty to discuss, starting with where the falls end. The honest answer is that nobody knows, but there is no shortage of commentators willing to guess. The forecasts we have seen from the big four banks put total falls somewhere between 9 and 12%, which would be astounding if it happened. What we do know is there is strong reason to believe the property boom that began in 2000 has ended, and we all have to adjust our thinking. That is no easy thing to do.

In stocks we have the CAPE ratio. In property we have the price-to-income ratio, and it is sky high. If history is any guide, there is a long way to go before it returns to the long-term average.

III. What's Your Edge?

Last week we promised to walk through this chart. If you are listening rather than watching, here it is.

Many people find it hard to settle on the right asset allocation. Part of the problem is the natural desire to maximise returns right now, when what matters is your return over time. That is where rebalancing comes in. Think of rebalancing as asset allocation at a different point in time: a way to increase or decrease your exposure as markets move.

The biggest error we see is over-allocation. People delay investing because markets are volatile, and then delay rebalancing because they believe the market has further to run and want maximum exposure until the last possible moment. Sorry, but you will not pick the top, or the bottom, every time.

The horizontal axis shows how far the market is trading above or below its normal level, and the vertical axis shows the share of the portfolio in stocks. Normal is the foundation allocation: at a long-term average valuation, you would hold 60% in stocks and 40% in bonds. Because stocks and bonds have tended not to move together, that mix has historically delivered smoother returns over the long run.

As the market rises above normal, the stock allocation steps down. Templeton's rule was that once the market traded more than 60% above normal, the stock allocation should fall to zero. At 30% or more below normal, it could rise as high as 100%.

Now think of that axis as the CAPE ratio, starting from 17 as normal. Here is how the levels line up.

On those numbers, Templeton's zero point arrives at a CAPE of about 27. At today's US CAPE of around 42, the market is roughly 147% above normal. Templeton would be out of the market.

That does not mean out of every market. Low CAPE markets have historically delivered higher future returns, so our focus is on the asset classes, countries and sectors that are still cheap.