Ready for the next market correction? Today’s drop rekindles questions of whether this bull market is finally over. To be sure, stocks are up over 7% in the first 4 months, extending the 8-year run from the 2009 low.
But the bull market run has resulted in some expensive prices. Regardless of whether one uses multiples relative to sales, book value, trailing earnings, or normalized earnings, stocks aren’t cheap. The Shiller P/E ratio, which compares stock prices to normalized earnings over a 10-year cycle, is at its third highest dating back to 1887. The top two instances were 1929 (before the Great Depression) and 1997 (during the Tech Bubble).
Berkshire Hathaway’s Warren Buffett released his annual letter to shareholders last Saturday, a publication that is examined and dissected by investors around the world. And this year’s edition underscores why.
Before its release, the S&P 500 closed at its all-time high (again), continuing its rally that began in November. In fact, in the first 38 trading days of 2016, the S&P 500 has posted a new high 11 times. The Dow Jones Industrial Average and Russell 2000 Index have printed new highs 14 and 3 times in 2016, respectively.
Even the greenest of investors is likely aware that stocks move in both directions, and that periods of upswings have historically been followed by downturns. The Holy Grail, of course, is how to invest through all the ups and downs, and Buffett offers his view:
Too much of a good thing can be wonderful, at least, if actress Mae West was right. But when it comes to your investments, we’d argue too much of a good thing can be downright
Consider what’s going on among blue chip stocks in today’s low yield environment. Anyone seeking income from bonds knows that yields are at historic lows. As such, many investors have sought blue chips stocks and their healthy dividends as an equivalent to traditional bonds. We don’t believe this to be a terrible idea, but it definitely comes with its tradeoffs and we question whether those risks and rewards are getting the attention they deserve today.
The last 18 months have been a volatile time in the market with fears of a Chinese recession causing a temporary market pullback in August 2015, Eurozone concerns causing a dip in February 2016, and Brexit triggering a quick decline at the end of June this year. Through all of that, the S&P 500 is actually up 3.67% over the last 12 months and 6.17% year-to-date. Because the S&P 500 is up 6%, your portfolio should have returned around 6% this year, right? Not necessarily, and if you’re in a diversified portfolio, likely not.
The problem with comparing a diversified portfolio to “the market” is that the S&P 500 only measures companies that make up a portion of a well-diversified portfolio. Football is top of mind as it is nearly football season again (HALLELUJAH!) so allow me to draw an analogy. Lineman, the largest players in football, make up only a portion of NFL football players. Comparing the S&P 500 to a diversified portfolio is like comparing the average size of an NFL lineman to the average size of an NFL football player. While players of the same sport are being compared, the comparison is apples to oranges because there are a large variety of statures in the NFL. The same goes for investing where there are countless asset classes available.
“What goes best with a cup of coffee? Another cup.”
Thus far, 2016 has been an interesting year for money managers. We have seen the recent market rally mask some of the greatest market volatility experienced in five years. If you think back to the beginning of the year, you’ll remember the worst start to the calendar year ever for the S&P 500. As recession fears subsided, stocks rebounded and we closed at a new record high on the S&P 500 yesterday. We have also seen a reversal in commodity prices.
From a total return standpoint, the S&P GSCI, the commodity index, sits atop of its equity counterparts. The increase in commodity prices have helped subdue the concerns of a global recession, but also comes with drawbacks. The clear drawback is the price to fill your car. We have seen prices at the pump increase over the year as oil prices have risen and now hover around $50 per barrel. Another downside, one not as publicized as other commodity prices, is the price of coffee.
The tragedy in Orlando last Saturday has shaken the nation while rekindling policy debates on gun control, immigration, and terrorism. These issues are among many cited by the pessimists as
catalysts for the end of the bull market in stocks. But the odds are that they’re likely wrong, and here’s why.
The coming weeks bring us the Federal Reserve meeting on interest rates and Britain’s vote on exiting the European Union. And as my colleague Kyle Kersting recently noted, the U.S. presidential election adds regular headlines that jolt markets higher and lower. The problem, however, isn’t the actual risk any of these topics pose, but rather how we feel about such risks.
Oil crisis in Russia. Bad debts in China. Impeachment proceedings in Brazil. Emerging markets have plenty of issues to navigate, but a closer look shows that much of these concerns are already baked into the stock prices, perhaps overly so.
Emerging markets present attractive long-term growth opportunities generally not seen in developed markets: Younger demographics, a growing consumer base with rising wages and debt-free balance sheets, and government policies that are opening up countries to outside investors.
But emerging market stocks have lagged their developed market counterparts badly in recent years. Since October 2010, emerging markets have declined 6.0% annually while U.S. large cap stocks (as measured by the S&P 500 Index) have gained 10.0% per year. The last time emerging markets lagged this much was when the U.S. went through the 1990s tech boom:
Investors have surely noticed the recent volatility in the global market place. In the first few weeks of 2016, we have experienced very volatile markets both domestically and internationally. The catalysts of the global sell off have been the volatility experienced in the Chinese markets and the plunging price of oil.
On top of the China’s current economic issues, devaluation of the yuan has added angst around the globe. Although China’s economy is the second largest in the world, its stock market represents a fraction of the global equities market. Investors need to remember that China equity falls are more correlated with short-term psychological factors rather than the underlying China economic conditions.