Look Out Below!!
Did that get your attention? Sorry, we just couldn’t help ourselves. The clever title is supposed to scare you into thinking we were talking about the market going down. If you read or listen to just about any news source, you have undoubtedly heard some expert warn about stocks going down. They have been doing this for several years. After all, we are in our ninth year of a bull market. It makes sense that we should get a meaningful downturn sooner than later. Doesn’t it?
The fact is that we will indeed have a meaningful market correction – sometime. Whether it is next month, or next quarter, next year or a few from now, we will indeed have a bear market, defined as a correction of at least 20% from a recent high. And when it comes, it will take many people by surprise. Most likely it will start innocently, with a pullback much like others we have experienced over the last few years. But then it will go further, and be accompanied by some really ugly news. By the time it is in full swing, we will all read or hear the precise reasons why it is occurring, and we will wonder why we didn’t take notice of that earlier. “Doom and Gloomers”, who have been forecasting a downturn since the March 2009 low, will finally be correct. (Remember a broken clock is correct twice a day.) And they will be the new talking heads and financial media darlings for a short period of time.
What can you do about this horrible fate that is destined to happen? Two things. First, you could do the easy thing, which is absolutely nothing. As a client of DHG Wealth Advisors, you already know that we do not attempt to time the market, nor use any specific formula to determine the correct stage of the current market. Had we done any of those things, we most likely would never have kept our clients in position to take advantage of this entire bull market.
There will always be good reasons to be scared and run to a cash position. Over the last several years there have been numerous explanations why someone would have to be crazy to be invested in global equities. Yet, our clients have received generous returns during this investment cycle specifically because we did not react to that ever present wall of worry.
Of course, there is a plan if the market has a meaningful correction. While others are fleeing from the market in fear, you will take advantage of the pullback as we use that time to rebalance your account by buying equities and selling income investments. Buy low, sell high. That’s what all investors attempt to do, but very few can.
There is a second way you can deal with a potential correction in the future. You can make a long term decision to ratchet down the risk level of your portfolio and choose a lower percentage of equity asset classes and higher percentage of safer short term income asset classes. Eight-plus years of mostly gains have placed some investors in a position of not needing their portfolio to produce as much return for the foreseeable future years, and they could change their portfolio’s risk/return parameters by decreasing equities and increasing income now, before there is any hint of a correction.
But before you become too concerned with this inevitable market downturn, there are reasons to believe that we are not close to reckoning day. Most big market corrections occur when a high percentage of people are in the market and when a lot of their accumulated cash has been invested in stocks. The two graphs below show that this simply is not the case at this time.
As you can see in the above annual Gallup poll, the latest available numbers show that stock ownership is at its lowest point since this polling data has been taken. Seldom does a market top occur when so few are invested in stocks. Compare the current 52% to 2007 at 65%. That was the year that the market peaked and the Great Bear Market of ’08-’09 started.
This above chart shows the total money markets/investment liquidity over the last six years, consisting of US Government securities, CD’s, commercial paper and other short term instruments. Note that there is no less liquidity now than there was in 2011 (nearly three trillion dollars). One would expect that when a market tops out, a meaningful amount of money market fund instruments would have been cashed in to buy equities. That has not yet taken place.
Obviously, there are no guarantees in the financial marketplace. Equities could have a major bear correction without having a large amount of investors in the market, or with huge amounts of money market fund liquidity still sitting on the sidelines. That has never happened before, but it is always possible. However, the probabilities are still high that when the market finally does start the downward part of its cycle, many more people and a lot more liquidity will be owning stocks compared to today.
You certainly want to always be prepared for whatever happens in the markets. But it is clear there are valid reasons you may want to “Look Out Above!” as well as below when you ready yourself for the next directional trend of the equity markets.
Second Quarter 2017 Asset Class Returns
The second quarter of 2017 continued the trends established in the first. Virtually all asset classes had low to middle single digit returns, with International Equity asset classes besting their US counterparts in every instance. At the end of 2016, many investors had given up on European equities, after years of underperformance. Some investors (not our clients) switched to US only portfolios to “insure” higher future returns. Of course, this was the exact time when a combination of Europe’s lower market valuations and a bit of economic strength kicked in, which is allowing for the current superior performance. All International equities asset classes have year-to-date returns in double digits, while Domestic classes are all mid to upper single digit.
For the umpteenth time, market results have proven the inability of market timing, the need for broad diversification and the necessity to view a portfolio from a long term perspective. Our clients are enjoying the fruits of this International outperformance because they were properly positioned when it started. This means they had to withstand the weak relative performance prior to this year’s strength, but it also means that their portfolio most likely took advantage of rebalancing some assets from the over-performing US equity asset classes into the underperforming International asset classes sometime during the last two years.
Both economics and politics continue to be prime reasons for the global markets’ past and future performance. The Federal Reserve continued its non-accommodative stance started late last year, while US corporate earnings have continued chugging along in a very orderly fashion. But politics has also been a reason for short term swings in markets at home and overseas. The fear of the European Union collapse after Brexit has been allayed by France’s election of Emmanuel Macron. In addition, upcoming elections in Germany currently point to Chancellor Angela Merkel holding that office. Even if she were to lose, it would be to another staunch supporter of the EU. So the most feared issue relating to Europe’s longer term economic growth seems to have been put to sleep for the time being.
However, US politics have not been sleepy in the slightest. Not only has Democratic vs. Republican debate been as fierce as ever, but there is also tumult inside both parties. Add the ever-present refusal of President Trump to abide by “typical” rules of that office and Washington is as wacky as it has ever been. More importantly, the extreme difficulty of getting any meaningful legislation passed has many market prognosticators nervous. The perceived inability of the Republicans to pass a new healthcare bill has many believing that the promised new tax legislation may also be dead on arrival.
Some market analysts believe that current stock market returns already have a new lower tax structure and a more pro-business environment already priced into it. Clearly, this and other political issues that may influence the economy are reasons for greater potential market volatility in the future. As always, we believe it is counterproductive to long term performance to try and anticipate the end result to any of these issues. Remaining disciplined and following a long term plan will allow our clients to take advantage of any political excitement that may occur.
Many of these issues will play out over the next quarter, and we will undoubtedly have much to discuss in our next report. In the meantime, stay cool in this “heated” time, and enjoy all the fun that the summer months provide.
Frederick F. Kramer IV, JD
Co-Chief Investment Officer