Broker Check

Yes, No, Maybe

August 17, 2016

Have you ever met or approached a professional at a social event and been tempted to ask a personal question that relates specifically to your circumstances?

I know I have.

Whether it’s a physician, attorney, or CPA, when I am in need of assistance, I benefit from receiving additional insight from the experts. Of course, I typically shy away from any direct questions. But the temptation sometimes arises.

While I am reluctant to pry a bit of free information from someone who has painstakingly developed their specialized skill set, I find that I’m very open to discussing financial planning with folks I meet when I’m out and about.

For starters, I truly enjoy what I do and I receive a tremendous amount of satisfaction assisting those who seek my advice.

However, there is one topic I shy away from–and it’s one I get questions about quite often: Where do I believe the market is headed?

Long term, stocks are an integral part of most portfolios, and the historical data bear this out. But many folks who ask me for my opinion want to know the market’s direction over a much shorter period.

You know, what’s going to happen after the U.K.’s Brexit vote? Or how will stocks perform before and after the election?

I understand the inquiry. Financial advisors have their fingers on the pulse of the market, the economy, and there is this expectation that we have some sort of inside information.

Although I did not expect what happened in Europe to have a lasting impact at home, admittedly, I was surprised by the sharp bounce in stocks and subsequent all-time highs in the Dow Jones Industrials and the broader-based S&P 500 Index.

In some respects, the political earthquake in the U.K. shook up our markets for just two days before cooler heads prevailed and shares began an upward ascent.

While I have reiterated in the past that I have no magic crystal ball (and let me remind you, neither does anyone else), let me take a moment to explain why my approach leans heavily on diversification and eschews market timing.

Yes, no, maybe

Irving Fisher was called “the greatest economist the United States has ever produced” by none other than Milton Friedman, who won the 1976 Nobel prize in economics.

Yet, Fisher’s record is stained by his 1929 remark that “stocks have reached what looks like a permanently high plateau.” Making matters worse, his comment came just three days prior to the crash (CNBC: “Spectacularly Wrong Predictions”).

Every so often, I am reminded of another blunder from Business Week.

In 1979, the respected periodical ran a cover story entitled, “The Death of Equities.” The article included this line, “The old attitude of buying solid stocks as a cornerstone for one’s life savings and retirement has simply disappeared…The death of equities is a near permanent condition.” (Forbes: “6 Doomsday Predictions That Were Dead Wrong About the Market”).

Three years later, stocks went on an 18-year bull run.

More recently, Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market hit the shelves in 1999, which was near the height of the dot-com boom.

I believe we will one day surpass 36,000. I can’t tell you when, but 17 years later, we reside near 18,000.

Bill Gross is not a household name for many, but in the financial world he is synonymous with bonds.

Yet, his expertise in fixed income didn’t prevent him from forecasting a drop in the Dow to 5,000 in September 2002 (PIMCO: Dow 5,000). One month later, the Dow bottomed at 7,286 (St. Louis Federal Reserve).

Just a few days ago, I spotted two conflicting headlines on a prominent business website (MarketWatch): “S&P 500 hasn’t done this in 40 years—and it’s a bullish sign,” and “These telltale market indicators suggest stock prices are topping.”

Well, which one is it? I view it as noise.

Simply put, very intelligent individuals don’t always get it right?

But what about the consensus? Would that offer solace? Not really.

The Bespoke Report reviewed the recent history of Wall Street predictions. Since 2000, the consensus among Wall Street analysts has never projected a decline in the stock market for that particular calendar year. Yet the market fell in five of those years (New York Times: “One Market Prediction Is Sure: Wall Street Will Be Wrong”).

While I could continue with the anecdotes, I believe I have demonstrated that market timing is ultimately an exercise in frustration and is likely to be a detour that takes you further from your financial goals.

An all-time high–how should I react?

During July, the S&P 500 Index finally eclipsed its prior all-time closing high set back on May 21, 2015 (St. Louis Federal Reserve).

An all-time high typically brings in two types of inquiries. It gives some investors a false sense of confidence, and they want to up the ante. Others decide a high is a good time to sell everything.

Given the abundance of caution in the economy and the high level of negative sentiment that abounds, I’m hearing the latter versus the former. But, again, I caution against market timing.

By itself, a new high isn’t a reason to sell.

Since the bull market started in 2009, there have been 45 record highs for the S&P 500 Index in 2013, 53 in 2014, and 10 in 2015 (LPL Research). Since topping the prior high on July 11, the S&P 500 has gone on to close at six more highs during the month (St. Louis Federal Reserve).

Again, by itself, a new high isn’t a reason to go to cash.

Table 1: Key Index Returns

                                                       MTD %    YTD %    3-year* %
Dow Jones Industrial Average         +2.8        +5.8          +5.9
NASDAQ Composite                       +6.6        +3.1          +12.8
S&P 500 Index.                               +3.6        +6.3          +8.9
Russell 2000 Index                          +5.9         +7.4          +5.4
MSCI World ex-USA**                     +4.9          -0.2          -0.9
MSCI Emerging Markets**               +4.7       +10.0          -2.7

Source: Wall Street Journal,
MTD returns: Jun 30, 2016—Jul 29, 2016
YTD returns: December 31, 2015—Jul 29, 2016
**in US dollars

What I do counsel is to avoid emotionally based decisions. In my experience, they rarely work.

When fear is high, some investors become uncomfortable with the equity allocation in their portfolio. This may even occur during a garden-variety correction that lops around 10% off the major indexes.

If this is the case, we may need to revisit your asset allocation, especially if your tolerance for risk has changed. In addition, changes in your personal situation may warrant updates to your financial plan. If that’s the case, let’s talk.

A look behind the rally

The upward move in stocks comes at a time of immense uncertainty among investors. Lingering worries about the global economic outlook haven’t subsided, China is still a concern, and Europe’s slow economic recovery and fragile banking system are problems that won’t soon be resolved.

However, the U.S. has been and remains the best home in what can only be called a rundown neighborhood.

It’s somewhat counterintuitive, but a post-Brexit world may actually be helping stocks in the U.S., as nervous cash in Europe seeks safety in the U.S.

But it’s not all gloom. While the U.S. economy is expanding at a subpar pace, it is growing, and the consumer is leading the way (U.S. BEA), which supports corporate earnings.

Speaking of earnings, once again Q2 earnings are topping a low hurdle (Thomson Reuters). More importantly, analysts are cautiously forecasting that the four-quarter earnings recession appears set to end in the current quarter.

Of course, projections aren’t set in stone. What happens to the economy, the dollar, and oil prices are all inputs into the earnings equation.

Oil prices took a dive in July, which will likely put added pressure on earnings in the energy sector. And the dollar has recently ticked higher, which may create added headwinds for firms that do a significant amount of business overseas.

Yet, it looks increasingly likely that Q1 2016 was the low point of earnings.

Meanwhile, let’s not discount the positive impact from strong corporate buybacks of shares.

Over the last 12 months ended March 31, S&P 500 companies shelled out a record $589.4 billion to repurchase shares of their own stock, according to S&P Dow Jones Indexes.

Undoubtedly, there is plenty of economic uncertainty, which discourages firms from making significant investments in new factories and equipment. But it’s not discouraging companies from trying to support share prices via buybacks.

Finally, a cautious Fed has been a plus for equities simply because low interest rates create less competition for stocks. If we were in a recession and profits were sliding, low rates would likely do little to support equities, in my view. But again, the economy is expanding, albeit modestly.

What’s an investor to do?

I recognize that we are in an uncertain period. As the economic recovery enters its eighth year (National Bureau of Economic Research), the expansion is no longer young.

It’s been a substandard economic recovery, global uncertainty is high, and we are in an unusual election cycle.

One of my goals has always been to assist you as you reach for your financial goals. That is why I strongly encourage a diversified portfolio that encompasses assets in the U.S. and abroad.

As I’ve mentioned in previous newsletters, we will eventually enter a recession, and recessions have historically brought about a downturn in stocks. I don’t know when it will happen, but it will. It’s an inevitable byproduct of a free market economy.

While declines in the major averages that exceed 20% can be unnerving, they have always run their course historically, setting the stage for another upward cycle that takes shares to new highs.

I hope you’ve found this review to be educational and helpful. As I always emphasize, it is my job to assist you.

Thank you very much for the trust and confidence you’ve placed in my firm.