Kevin Michels, CFP®, EA
The market news lately has been replete with the phrase “new market high”. The S&P 500 index and the Dow Jones Industrial Average index are at all-time highs. These indexes have surpassed the 2014 peak, which was the last time we were told the market was too high.
The reality is that the recent market high has only slightly surpassed the 2014 high, climbing a wall of worry in 2015 of various global and national events. The 2014 high was the result of a gradual crescendo that started in the Spring of 2008 in the depths of the financial crisis of 2007-2008. Surprisingly the 10 year annualized S&P return to date is (only) 5.16%. With dividends reinvested, the annualized S&P 10 year return is 7.32%.
With these comparatively tepid returns on the major stock market indexes in the past 10 years it would be a stretch to say we are now in a bubble, considering we have spent a number of those years playing catch-up.
I am reminded of the customer in 1995 when I worked at a national stock brokerage firm that called me to liquidate his entire stock portfolio. “The stock market was too high,” he said. He was 6 years too early, and missed some great returns.
Time, not Timing
Is now a good time to invest? Of course this is a loaded question. For me to answer in any professional capacity this question I would have to know more about the individual’s personal financial plan, their risk aptitude, and their financial goals just as a starter.
I think of the tongue-in-cheek question/answer:
When is the best time to plant a tree?
Answer: Twenty years ago.
When is the second best time to plant a tree?
To alter this, the best time to invest was 20 years ago (or 10 years ago, or xx years ago).
The second best time to invest is today.
In the case of the tree and in the case of investing we are making a big assumption here:
We are looking at the long-term. We have no intention of uprooting the tree or bailing out on our investment plan in the near term.
Speculative stock market timing is a different game. I have just as good of odds predicting whether the stock market will be up tomorrow as flipping a coin.
Most investors will have a diversified portfolio that includes mid-cap stocks, small-cap stocks, and international stocks as well as large cap stocks such as found in the S&P 500.
Of course, these equity investments are also typically subdivided into the broader categories of “Growth” and “Value.” Which means most investors that believe in diversification will own four different “types” of stock, each divided into two different categories for eight different baskets of stock if you will. The typical daily news will focus only perhaps on the S&P 500, which is a portfolio of large capitalized growth stocks. This is only one of the eight different types of stock that an investor would typically own.
In strong bull markets, typically all eight categories of stock go up together with some degree of correlation. This is also true in strong bear markets with all eight categories of stock going down in some degree of correlation. Portfolio managers typically try to offset high correlation of investments by owning investments in asset classes that typically do not all correlate together. This is a major technique used to reduce the volatility in an account.
Back in 2014 I posted an article “Stock Market at New Highs!” on the Medical Executive-Post. I come to the same conclusions.
- The Market Indexes at new highs does not indicate a bubble. In fact, the market should, relatively speaking, regularly be hitting new highs because of the consistency of positive inflation. Prices of goods and services today are at all-time highs. Does that mean we are in an “inflation” bubble? No. This is normal.
- The S&P 500 is not an accurate measure of the US economy. While the S&P 500 is the common “market” indicator in the US, only about 55% of the earnings of the index come from the US. (Source: RBC Capital Markets Research, Capital IQ 2012). This is because mainly large multinational companies such as Google, IBM, and Apple that have a significant amount of overseas revenues weight the index.
- The S&P 500 or the Dow Jones Industrial Average (DJIA – 30 stocks) is most likely not an exact reflection of your personal stock portfolio, which would expectantly be more diversified. A typical well-diversified long-term investment portfolio would include not just large cap stocks (such as found in the S&P 500 or DJIA), but mid, small, and international stocks from the growth and value camp, as well as a diversified bond holding.
- Overpriced stocks, just like overpriced real estate, are more prudently ascertained by value measures, not simply by raw index numbers. A stock hitting new highs could still be quite undervalued. Meaningful variables such as earnings growth, price to earnings ratio, dividend yield, price-to-book, price-to-sales, and other metrics should be considered.