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How to Turn a Profit from the Market’s Unknowns

3 | By Shah Gilani

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.

Here’s what you need to know about the unknowns we’re facing right now, and how to use them to your advantage…

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.

  1. Taxes

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.

  1. 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.

  1. Deregulation

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.

Sincerely,

Shah

3 Responses to How to Turn a Profit from the Market’s Unknowns

  1. Doobe Bro-ham says:

    Complexity could collapse at any time. Thats good the education of that fact has spread like digitalization. Many more are aware of worst case. But i have 3 examples of solutions to 3 prong cattle prod you laid out. Just to start off though, we are at the end of a 33+ year King Trea$Ury bill Led [w lead & everGreen gold we can grow at any time in our land we auction to citizen companies] mmmarch of global banking harmonization & ‘stake-selfinterest’ exchange INCENTIVIZATION possibility. Just because it works preProsperously wealth for the game on wealthy all ready ready to giddyup already again and again IS NO reason to fall all over ourselves w reckless abandoning ships like fallingmen everywhere. By the way , your welcome E-trade for the past posts. Send me a thankyou if not a check. the marketing teammates read Shah and michael Lewitt and KF im sure. My 3 solutions are next.

    • Doobe Bro-ham says:

      1. For the tariff proposal, no good answer except to keep all monies from each Companies country of origin in an investment trust to be annuitized somehow for a chosen block of that Country’s population most in need +ablility to make best growing use of micro loans from that fund…which itself invests in same American counterpart Industry funding companies with best &innovative labor-stakeholder/ing program. Voted on by the industry participants. BUT FOR the border tax affecting importers & pass on ca$ts to Consumers usa: have the i.r.s do something useful while they’re still being paid to make our country fund itself given Current Seen structure : let them invent a form that shows profit margin and base that company’s tax rate below the Base 15%flatline, on a graduated exact % depending on how many workers they pay & what % of profits go to payroll. This way , Low Margin consumer facing & consumption oriented retail wont fail with wrong kind of retail markup overinflation that the bottom THIRD of the country will throw that Cake through the windows, or take it with the race & class baiting being band aided about.
      2. STIMULUS PROPOSAL

      • Doobe Bro-ham says:

        Solution #2 Stimulus is Fact Based on past Tax Return Provable & stored Data.
        Use any 1 years taxes paid up age 30 if married, 27 if single. Any lifetime successive 2-year average taxes paid up to age 40 if married, 35 or so if single. & likewise…the purpose is to incentivize the youth to participate and be involved in FAMiliarizing themselves with Sharing stakeholding solution oriented growing of society instead of reinventing cogs & wheels. So they get a credit advance based on future expected taxes 1 year at a time that may be an expandable program tied to parameter, but Base case based on taxes paid and Deal Involves perhaps half of credits are in a uniform basket of U.S. TIPS, and the rest is performance self directed if you choose. Also full 5% to cover TIPS portion @50% of the Amount, as rule of thumb being 10% gold to anchor bond risk. Being Inflation Protected Securities as opposed to nominal variety during previous falling apple down interest rerates world .
        Takes wealth effect to workers because you can expect someone who works for decades to work next year…let them participate, not just the presidents men in suits for barely keeping stock floating to cash out their stock options. THEN YOU CAN NATURALLY BE VERY CREATIVE WITH THAT EXTRA BID PARTICIPATION SPREAD OUT IN CURBING BUYBACKS IN ORDER TO SPARK OFF ********THE GREAT GROWTH RUSH*******and grow into the P/E , which as Profssr Epstein points out, aint so damn bad when you take out the post war crisis sky high rates out of the market mortality Numbers. Duh? Add in the TECH companies huge benchmark warping prescense. How much R&D is Accountable ONLY as a Cost, and never as any measure of Return. How much do they warp P/E.Another consideration atop of Siegels or Epsteins p?e of 18_19 when take out the Volker Crisis type Credit Resets/Game Overs DefCON$

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