Happy spring season to everyone! It may not feel like it just yet but the first day of spring was March 20th. All winter my kids seem to build energy just waiting for that day when the weather finally breaks and they can explode. If you have experienced kids then you can understand my overwhelming anticipation for spring to truly arrive with the promise of warmer days ahead. To our delight, it seems the markets have been experiencing a little bit of energy release and euphoria similar to my kids on those first warm days. The allure and promise of good days ahead seemingly created a newfound confidence for investors of all risk appetites. While enjoyable now, we must keep our expectations in tact for the long run. Make hay while the sun shines certainly, but be careful to store some seed for the next season!
Be fearful when others are greedy is common wisdom echoed by many great investors over the past century. It seems relevant to consider this quote today as anytime 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. The streak was finally broken on March 21st with a slightly greater than 1% decline. The streak was the seventh longest in stock market history for the Dow and the 10th longest for the S&P 500. Year to Date the Wilshire 5000 (stock indicator) has increased 4.08% and the Barclays Aggregate Bond Index has increased 0.72% (Folio Institutional Data). A solid start to the year for investors of all risk levels. Since the election (11-4-2016), the Wilshire 5000 has increased 12.91%. To put in perspective, this marks all of the gains since 3-22-2014. Let me say that a different way, since 3-22-2014 (3 years ago) the Wilshire 5000 has gained 11.09%, with all of this return coming since election day. Great lesson about how markets can tread near 0 return for lengthy periods, almost 3 years in this case and then gain quickly. So with solid gains over such a short period what might we expect, should we start to be fearful with others greedy?
Peak Under the Hood
We are now over 8 years removed from the market bottom of March 2009, when recovery from the 2008/2009 great recession began. With over 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 do not see any imminent signs of major declines, we remain cautious of a possible future bubble. In fact we would prefer to see some added volatility 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 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 cash flows for 2017. The expected earnings rate for the S&P 500 for 2018 is $146.75 (about 6.1% earnings on todays value), up from this years expected $131.28 (5.5% on todays value). This implies the market as a whole is expecting earnings to accelerate by over 11% growth from now through 2018. 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 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 (ups and downs) as the timing of these macro events ebb and flow against a backdrop of each companies individual success or lack there of.
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 response, which often drive market behaviors over the short run. History shows plenty of examples when markets will charge through fair values or normalcy as no compelling alternative for placing 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 allocating more into stocks. 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.
Evergreen Wealth Actions
It is not time to worry – not that you should ever worry long term. However, if markets continue to charge forward we should maintain a healthy expectation for volatility ahead. My family will enjoy the spring and warmth when it comes, but we must not neglect the opportunity it gives us to prepare for winter. Seasons can not be avoided BUT preparation is within our control. Evergreen will spend this season with an extra emphasis on 3 items:
For Income Accounts – increased balance sheet analysis to validate security of income payouts and ability of companies to withstand any sustained declines
All Accounts – increased correlation analysis of assets classes for validating downside risk continues to align with designed portfolio risk thresholds
All Accounts – Opportunistic rotation as values change with an emphasis on profit taking and larger margins of safety for new investments
While we cannot avoid declines, the preparation we take today will yield great benefits for the years ahead to continue protecting and meeting your goals and objectives!
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 sun, you have 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.
*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.