posted on August 15th 2016 in Market Commentary with 0 Comments /

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?

Whether it’s from a physician, attorney or CPA, insight from professionals benefits us all when we need assistance in their field of expertise.

While you may be reluctant to pry a bit of free information from someone who has painstakingly developed their specialized skill set, we find people are often very open to discussing financial planning with us when we meet them out and about.

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

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

Long term, stocks are an integral part of most portfolios, and the historical data bears this out. But many folks who ask us for our opinion want to know the market’s direction over a much shorter period, e.g., what’s going to happen as a result of the UK’s Brexit vote? Or how will stocks perform before and after the election?

We understand the inquiry. Financial advisors have their fingers on the pulse of the market and the economy, which leads to the expectation that we have some sort of inside information.

Although we did not expect what happened in Europe to have a lasting impact at home, we were 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 UK shook up our markets for just two days before cooler heads prevailed and shares began an upward ascent.

While we have reiterated in the past that we have no magic crystal ball (and neither does anyone else), let’s take a moment to explain why our approach leans heavily on diversification and eschews market timing.


Getting it right is hard — even for the experts

 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.

Ever so often, we are 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.”

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.

We believe we will one day surpass 36,000. We 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. One month later, the Dow bottomed at 7,286.

Just a few days ago, two conflicting headlines on a prominent business website: “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? We 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 a particular calendar year. Yet the market fell in five of those years.

While we could continue with the anecdotes, 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 you react?

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

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.

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. Since topping the prior high on July 11, the S&P 500 has gone on to close at six more highs during the month.

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, MSCI.com; MTD returns: June 30, 2016 – July 29, 2016
YTD returns: December 31, 2015 – July 29, 2016, *Annualized, **in U.S. dollars

What we counsel is to avoid emotion-based decisions. In our 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 sounds like you, 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 across the pond.

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

Speaking of earnings, once again Q2 earnings are topping a low hurdle. 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. But again, the economy is expanding, albeit modestly.

 

What’s an investor to do?

We recognize that we are in an uncertain period. As the economic recovery enters its eighth year (National Bureau of Economic Research), the situation 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 our goals has always been to assist you as you reach for your financial goals. That is why we strongly encourage a diversified portfolio that encompasses assets in the U.S. and abroad.

As we’ve mentioned in previous newsletters, we will eventually enter a recession, and recessions have historically brought about a downturn in stocks. We 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.

about the author: WorthPointe Wealth Management

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