Investing Insights

In April 2017, Articles, Investment Management by Adam Cufr

by Stephen L. Hanley

Chartered Portfolio Manager® and owner of Evergreen Wealth Management, Stephen Hanley, assists many of our clients through customized portfolio solutions and sophisticated investing strategies. Each quarter he’ll be sharing his investing insights with us in an effort to provide context for the events of world markets.

 

Change of Seasons

Happy spring season to everyone! As always, it was a long Northwest Ohio winter, but spring is finally here. There’s nobody more grateful for this occasion than children. All winter, my kids seem to build energy just waiting for that day when the weather finally breaks and they can explode through the doors to enjoy the warmth. If you’ve spent time with kids, then you know that overwhelming anticipation for spring to truly arrive with the promise of sunnier days ahead.

In a similar fashion, it seems the markets have been experiencing a little bit of energy release and euphoria as well. The anticipation of good days ahead seemingly created a newfound confidence for investors of all risk appetites. Things have been going quite well in the stock markets. And while this growth is to be enjoyed, we must also keep our expectations well-grounded for the long-run. Make hay while the sun shines, but be careful to store some seed for the next season!

‘Be fearful when others are greedy’ is wisdom echoed by many great investors over the past century. It seems relevant to consider this sentiment today as much as any time in recent memory. March 15th marked the 106th consecutive trading session that neither the Dow Jones Industrial Average (DIA) nor the S&P 500 (SPY) declined 1% during any one day. That streak was then finally broken on March 21st with a slightly greater than 1% decline. This is notable for investors because the streak was the seventh longest in stock market history for the Dow and the 10th longest for the S&P 500. As of the end of the first quarter, the Wilshire 5000 and S&P 500 (stock market indicators) have increased 5.12% and 5.53% respectively. The Barclays Aggregate Bond Index (bond market indicator) has increased 0.79% (Folio Institutional Data). These are very solid gains to start the year for investors of all risk levels.

Another interesting fact is, since the election (11-4-2016), the S&P 500 has increased a whopping 13.31%. To put that in perspective, since 3-31-2014 (3 years ago) the S&P 500 has gained 26.19%, with over 50% of these returns coming since Election Day. This is a great example of how markets can experience low returns for a lengthy period, almost 3 years in this case, and then catch up quickly, surprising investors. Patience pays off again. So with solid gains over such a short period, what might we expect going forward? Should we start to be fearful with others appearing greedy?

Peek Under the Hood

We are now over eight years removed from the market bottom of March 2009, when recovery from the 2008/2009 great recession began. With a 223% return from the S&P 500 since 3-1-2009 (Source: Morningstar) it is natural to ask, when is the next big decline coming? While we don’t see any imminent signs of major declines, we remain cautious of a possible future bubble. In fact, we would prefer to see some added market volatility (ups and downs) this year to keep valuations, emotions, and investors in-check, and hopefully keep mob mentality of greed away from the general markets. However, we also know it’s vital we stay the course and capture the good times when they come relative to acceptable risk.

As a whole, the stock market appears to be overvalued by around 5-10% based on expected company cash flows for 2017. How do we know this? The expected earnings rate for the S&P 500 for 2018 is $146.75 (about 6.1% earnings on todays value), up from this year’s expected $131.28 (5.5% on today’s value). This implies the market as a whole is expecting earnings to accelerate by over 11% growth from now through 2018. Where is this expectation coming from and is it possible? It appears this expectation of growth comes from a belief in future tax relief, decreased regulation, continued stable interest rates and stock share buybacks. While certainly possible, we seriously question the ability for administrative policies to gain approval and work into company profits at such a quick pace. A healthy response from the markets would be increased volatility as the timing of these macro events ebb and flow against a backdrop of each company’s individual success or lack thereof.

On the flip side, we must remember the power of stable / inflationary environments to take the markets much higher than is otherwise considered fair or normal. After all, the market generally moves in anticipation of what might happen and not what has happened in the past. In a perfect world, markets pause and take a deep breath giving us little return or perhaps a slight decline as company earnings and cash flow catch up to current valuations. But we live in a world of emotional responses, which often drive market behaviors over the short-term. History shows plenty of examples when markets will charge through fair values, as no compelling alternative for investing money exists. Given the choice of safer bonds yielding 2-3%, a savings account yielding near 0% or stocks with a projected earnings rate of 5-6%, most will lean toward increasing stock exposure. While this is the right decision long-term, it also means more “fearful” investors are heavily invested in stocks. The longer this trend continues the less effort it will take to move the market down. An unexpected event that creates a little fear will likely drive the more sensitive short-term investors to sell stocks and create a market decline. The longer the market goes without a significant decline (10% or more), the larger the number of “fearful or sensitive” investors becomes. In simplest terms, this is how stock bubbles are created. We have seen many investors, both corporate and retail, continuing to move money from the “sidelines” and into the market during late 2016 / early 2017. Since 2009, many investors have kept larger amounts than usual in savings accounts yielding little to nothing. In addition, many corporations have improved efficiency with lighter work forces and larger cash holdings; leaving them with increased flexibility to buy back company stock and stabilize or push prices up. Agree or not, we also have an administration that is determined on driving favorable economic policies from both a business centric aspect as well as possible government stimulus spending. These forces could continue to drive prices upward barring any “fearful” event that spooks investors away. In short, there are still reasons to think equity markets will act favorably for a while longer.

Let us make hay while the sun shines, the farmers say. But also let us save up some extra seed for rainy (or dry) days whenever they may come. Enjoy the sunny warmth, you’ve earned it!

Evergreen Wealth remains committed to providing holistic investment solutions and financial planning. We remain honored for the trust you place in our wisdom to continue stewarding your assets and retirement journey.

Important Disclosures

*Results mentioned were taken using client accounts at Folio Institutional. You should login to your own account to view actual results specific to your accounts.

Evergreen Wealth Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.

Index results do not reflect management fees and expenses and you cannot typically invest in an index.