The Immaculate Market
The prior three months were a good time to be an investor. In fact, the prior eight-plus years have been a great time to be an investor. U.S. stocks advanced 4.5% in the last quarter, which, is really just more icing on the cake for indices that have more than quadrupled in value since 2009. Making things even sweeter, investors have had a rather smooth ride of late. Volatility has remained muted, resting dormant at multi-decade lows. The major stock indices have not experienced a true price correction* since February 2016, which was almost 600 days ago. This pleasant journey continued over this summer despite a plethora of potential reasons for concern. Present conditions in the financial markets have been so pleasant that one might call the markets immaculate. As we continue to witness prices climb higher, the market seems to be allowing worries to drip off into a puddle of indifference. In other words, everything is apparently awesome.
Third Quarter 2017 Percentage Returns
Despite a long list of worrisome events, such as: increased hostility with North Korea, terrorist attacks, a Catalonian vote for independence from Spain, a failure by Congress to pass a new healthcare bill, uncertainty over who our next Federal Reserve Chairperson will be, and multiple hurricanes that brought devastation to major economic hubs in our own country, investor optimism reigns supreme at the moment.
While there is hardly ever one reason the financial markets act in a certain fashion, one major contributor to the recent ebullience is the prospect of tax reform. For many years, political and business leaders alike have criticized our tax system as being overly complex and unattractive to large corporations, particularly those generating a large portion of their business from overseas. Now it appears the stars may be aligned for a tax bill to slog its way through our painful legislation process. It is reasonable to assume that any type of reduction in corporate and personal tax rates would, at a minimum, provide a temporary boost to economic growth.
The potential relief of tax reform comes at a time when revenues and earnings for companies domiciled in the U.S. are already projected to demonstrate healthy growth rates. The most recent estimates assume publicly traded U.S. companies will see their earnings per share accelerate to a double-digit annual growth rate next year. Furthermore, these estimates are supposedly not accounting for any boost from lower tax rates. Should this prove to be true, it is not unreasonable to assume markets stand a chance at extending their gains into next year.
Critics will, of course, point out that valuations for U.S. stocks are high, which is difficult to deny. The forward price-to-earnings valuation for U.S. stocks does currently reside above both its five-year and ten-year averages. In fact, some have argued that U.S. stock valuations have only been higher twice before, in 1929 and during the late 1990’s technology bubble.
However, one discernible difference exists between history and now: the level of interest rates. Looking back in history can be helpful when investing, however, what is equally, if not more helpful, is looking at what is happening right now. Right now interest rates are at or near record lows across the globe. As Warren Buffett pointed out in an October CNBC interview, a key determinant in valuing businesses is the level of interest rates. Cash pays next to nothing currently, and 10-year U.S. Treasury rates have remained below 2.6% this year. Even riskier, high-yield debt has offered meager average yields of 5-6% so far in 2017. To put it simply, for investors with a high tolerance for risk to invest their money, the stock market remains the most rational, or least worst, option.
What Should You Do?
We humbly admit that we do not possess the required sorcery to know precisely when markets will turn and head the opposite direction. For this reason, the prudent way to invest for the future is to set risk budgets or parameters for your investment model, and then invest according to those mandates. Our investment models never try to make timing decisions or market calls because market timing has proven impossible to consistently get right.
At Allen Capital, we sit down with each of our clients to understand their unique needs. After getting to know a family’s situation and planning a unique path forward, we then invest according to a determined risk tolerance. While we would love to see the markets continue to march higher, we choose instead to construct investment models that meet investors where they are. We offer our clients models with downside protection options to preserve their investments, and we offer models that ebb and flow with the overall market.
As always, we encourage regular communication with your financial advisor. Understanding you is our utmost priority and we value being a part of your financial journey.
*Price correction is a situation where prices decline by more than 10% from the highest price of the year)