Investing should be easy. It’s not.
Most investors don’t invest in what they know, and don’t know how to invest in the unknowns that scare them.
In 2007, nearly two out of three American adults (about 65%) invested in the stock market. Now, according to a 2016 Gallup poll, only 52% say they have money in the stock market. That matches the lowest rate in Gallup’s nineteen years of tracking ownership trends.
In recent years, American investors have been through the 2008 Financial Crisis and the subsequent Great Recession, then the May 2010 flash crash, the summer of 2015’s two-thousand point drop, and another 2000-point drop in January 2016.
All this wasn’t enough to scare investors out of the market – the Dow’s up more than 210% since its 2009 bear market lows.
But now we’re worried about Trump tweets, political fireworks, a divided America, and global uncertainties.
The truth is, there’s always some unknown out in the market to be scared of. But that doesn’t stop stocks from rallying. That’s why you need to stay in the game.
What’s the Market’s True Present Value?
Fundamentally, the market is strong. That’s because, in the biggest picture possible, there are fewer and fewer stocks to own while more and more capital is created every day, a lot of it chasing that diminishing pool of equities.
Between buybacks, mergers and acquisitions, leveraged buyouts, and the lack of new companies coming to market, there are one-third fewer companies traded on U.S. exchanges than there were in 1999.
Considering tepid global growth, central bank money-printing, and rising stocks (which smart investors use to leverage themselves by buying more shares on margin against their appreciating portfolios), there’s been a lot of capital created that’s gone into the stock market.
Of course, low interest rates help the stock market enormously. With fixed income yields so low, investors seek greater returns. Low rates also make it cheap to borrow to buy back shares, to finance takeovers, and leverage up portfolio holdings with margin.
More capital chasing fewer shares creates a giant “bid” under the market.
The question to ask now is, what’s the “present value” of the market?
Has it gotten ahead of itself? If it dips, will the big-picture fundamental bid under the market stabilize it and push it back up? Are there other potential “bids” under the market, capable of lifting stocks? What are the unknowns, and how could they impact the markets?
There’s no question that – in terms of historical price/earnings ratios – stocks are very expensive.
Last week, I showed you how expensive stocks are. By one measure (price to earnings), the low end has them at about 35% overpriced, while the high end measures them at almost 90% overpriced.
Most recently, analysts are expecting earnings to start improving after six quarters of decline. Stocks already rose through declining earnings, so surely an upswing in earnings will now draw more investors into more stocks.
We’re heading into the thick of this earnings season. Even though analysts have trimmed their year-end 2016 estimates for earnings growth in the fourth quarter from a gain of 6.1% for the S&P 500 to a gain of 4.2%, they are coming in on the upside. That’s a positive for the market.
In present value terms, however, it’s impossible for earnings to increase enough to justify the high PE ratios we see today, even at the pace they’re coming in this quarter. That’s worrying markets.
That said, all the scares the markets faced since 2009 have only – very temporarily – stunted stocks’ extraordinary march higher.
Investors who now look to the future optimistically are banking on the fact that if we haven’t fallen backwards when negativism prevailed under a less than business friendly administration, a new very pro-business president and administration will only encourage investors back into the market.
That brings us to the known unknowns, how to see them coming, and how to invest around and through them.
The Three Known Unknowns
The Trump Trio that the markets are banking on are lower taxes, stimulus spending, and deregulation.
Taxes could be a negative as much as they are a positive. On the positive side, President Trump’s call for lower corporate taxes puts more money into business treasuries, which will be used to buy back more shares and support stock prices. Lower taxes on individuals puts more spending power in their hands, which means more consumer consumption, pushing stocks a lot higher.
But the battle over tax cuts hasn’t even started. If we don’t get the kinds of tax cuts markets want to see, they may pause instead of rally… and there may be some profit-taking.
The other side of domestic tax cuts are border taxes and tariffs. The President wants to tax imports from Mexico and China and elsewhere. A global tariff war could erupt as a result of heavy-handedness on the part of the new administration, and it’s a threat to our global economy. Stocks will start slipping if countries start imposing new or steeper tariffs on American imports.
- Stimulus Spending
The money for stimulus spending isn’t sitting on a table somewhere. How Congress battles over stimulus spending, and what happens to the deficit and interest rates if there are large stimulus packages proposed will be quickly translated through the stock market. Stocks could start sliding if there isn’t much stimulus coming our way, which would have to be large enough to move the needle in America’s $18 trillion economy. Even if there is proposed stimulus that could blow up the budget and the deficit, it would cause a spike in inflation and interest rates, forcing stocks to react negatively.
Then we have deregulation. Wholesale slashing of regulatory protections that safeguard us all, for the sake of greater corporate (i.e., banks) profit, aren’t going to come easily. Still, any meaningful deregulatory push will be a positive for stocks. The problem is that a lot of industries have been priced higher based on Donald Trump’s desire to cut regulations. If those regulatory cuts don’t materialize, a lot of companies whose stocks have been bid up on account of expected deregulation would probably lead the market back down the slippery PE slope.
Sure, there are unknowns ahead. There always are. But not only have they not impeded the market, they may never happen. The positives the market’s prepared for could be in the offing, sending shares higher.
The market’s a very manageable beast, but not from the sidelines. You’ve got to be in it to win it. Be smartly invested, watch how stocks react to these unknowns, have a plan to get out with profits and then back in as soon as the coast looks clear. These are the keys to your financial future.
On Friday, I’ll tell you how to build a “Trumponomics” friendly portfolio… and what to do if the country or Congress isn’t so friendly to his pro-business agenda.