With Risk Premium Vanishing From the Market, it's Time to Shoot for Par

Golf aficionados have a big weekend ahead of them as the 124th U.S. Open is being played on historic Pinehurst No. 2 in North Carolina. This will be an absolutely brutal test of the finest golfers in the world where plus-three or -four might end up being the cut line. 

Par is more than a good score on most holes in this gauntlet and players will have to accept taking a bogey when necessary. Avoiding double and triple bogeys will be key to making it to the top tiers of the leader board. The top golfers are not generally aiming at the pins in this open, they are targeting the center of every green. This means fewer birdies but more pars and, more importantly, fewer bogeys and worse. If they find themselves short-sided by a bad hole, they are not likely to attempt a risky recovery shot but to keep the damage to no more than a loss of one shot on the hole.

Navigating through the open offers lessons for investors within the current market, as equities feel like they are at the tail end of a bullish phase. 

The market has a very top-heavy feel to it, much like the end stages of the internet boom. NVIDIA Corporation NVDA has replaced Cisco Systems CSCO from that era as it has become synonymous with the build out of AI. Now, I do believe this is as big of a paradigm shift as the birth of the internet, but values in the market have become more than frothy and breadth is "tepid," to be kind. 

The Federal Reserve first launched the most aggressive monetary tightening since the days of Paul Volcker back in March 2022. The market was trading at just over 22-times trailing S&P 500 earnings per share at the time and spent most of the year in purgatory. If one looks at the last four quarters of S&P 500 profits per share, there has been no growth from the four quarters leading into the first rate hike approximately nine quarters ago. Now, earnings are starting to grow again but equities are valued at some 27-times trailing S&P 500 earnings and nearly 22-times forward earnings. This is in an environment where the Fed funds rate has risen by some 500 bps in an effort to squash the highest inflation levels since the early 1980s. The effort has borne some fruit, but we still have some way to go to get down to the central bank’s official 2% inflation target. 

Now, I know we are entering an era where most of the nation will soon be skinny thanks to the proliferation of GLP-1 drugs and most of us will have AI-powered robotic servants. However, I would project that a good deal of that utopia is already priced into the market with the major indices at all-time highs. Therefore, the play for me is to aim at the center of the greens and take few chances. 

Roughly half of my portfolio is in short-term treasuries, paying just over 5.3%, and almost all of the rest is within covered call holdings around equities that still have reasonable values. Pars are just a good score within a market that has little to no risk premium to it.

At the time of publication, Jensen had no positions in any securities mentioned