October 15, 2017
To: Customers & Friends
From: Christopher Weil & Company, Inc.
We are hearing the question these days with some frequency: “Is the market too high?”
My first-level response (really more of a hedge or non-answer, some will say) is that the question doesn’t make sense because there really is no single “market.” Rather, there are scores of different markets and market sectors—domestic, international, frontier, emerging; micro-cap, small-cap, mid-cap, large-cap—and these different markets don’t necessarily move in sync with one another. Some might be “too high” while others are not. The fact that there is not really a single “market” makes it hard to definitively answer the question, “is the market too high?”
Not surprisingly, most people asking the question aren’t comforted by my first-level response. But imbedded in it is a fair point we should not lose track of: if the questioner is really asking “should I be a buyer or a seller of equities?” then it is totally fair to respond with the question, “which equities?”(1)
Given that the anxiety behind the question “is the market too high?” is not much assuaged by such esoterica, I suppose I owe it to the questioner to move to a second-level response.
For purposes of this second-level response, we can assume that the “market” the questioner has in mind is really the U.S. stock market taken as a whole, or (rather) one or more of its supposed proxies: the Dow Jones Industrials, the S&P 500 and the NASDAQ. To be fair, there is some justification for ignoring a number of markets (mid and small-cap, international) and blurring the distinctions between others, and instead, thinking of these three proxies as a consolidated “market” for discussion purposes (recognizing that the three components of this consolidated market often—but by no means always—move more or less together).
Reinforcing the logic behind this shorthand definition of “the” market is the reality of significant investor consolidation into mutual funds and exchange traded funds, many of which do in fact represent proxies for these three markets. (2)
But let’s get back to the question of investing in equities and the question of whether the broad U.S. equity markets, as so defined, are too high. In fact, there are any number of other questions packed into this one, and breaking them down can lead to a more-or-less satisfactory answer to the question as a whole:
Are we in any kind of obvious bubble? Not that we see. There are few of the classic signs of a bubble: no widespread euphoria, no abundance of problematic debt, few people giving up their day jobs to become day traders. (But whether bubble or no, do not forget that markets are volatile and that material swings in valuation are the inevitable by-product of market participation.)
Are popular indices high by historic standards? Generally (and with some important exceptions) yes.
Is there any justification for current price levels? Yes.
Is the market experiencing what then-Federal Reserve Board Chairman Alan Greenspan once characterized as “irrational exuberance?” There are certainly some now saying that this is an exuberant market. (3)
Do I think the exuberance is justified? Maybe.
Against this backdrop, you could say, perhaps, that we are “suffering” through a period of rational (rather than irrational) exuberance. Part of this rational exuberance is nothing more than the widespread recognition, translated into (some) stock prices, that the deep wounds inflicted on the economy in 2008/09 have taken all these years to heal, and that the healing process has been accompanied by some significant element of creative destruction/reconstruction which, ironically, has resulted in an economy stronger and more resilient than would have been the case had 2008/09 never happened. And part of current rational exuberance arises from the recognition that, all the good reasons not to invest in equities notwithstanding, the prospects for our future economic well-being are favorable, (4) and that future measurements of prosperity, however defined, will compare very favorably to where we are now.
So that is a partial, and partially hedged, answer to the question, “Is the market too high?” But I think we have some more unpacking to do. Because among the other concerns imbedded in the question are almost certainly these: “Should I be worried about a material decline in stock prices - particularly in my account?” “What should I be doing if the answer is yes, or maybe even if the answer is maybe?” “As my financial advisor/manager, what should you be doing, or are you doing, if the answer is yes, or maybe even if the answer is maybe?”
On the assumption that these are some of what’s really going on in the mind of the person asking, “Is the market too high?” as a third-level response, I offer this cautionary tale. (This tale illustrates just one of the many ways in which market timing can lead to unpleasant outcomes - but this is certainly one of the more popular scenarios.)
Mr. Bee, an experienced investor, concludes that “the market is too high.” He has reasons, including the fact that there has been an extended bull market, at least in the markets measured by the popular market indicators. And the financial press as well as the cocktail circuit are communicating that “the market” is “poised” for a significant correction. So Mr. Bee decides to sell his substantial equity portfolio and capture current “high” prices and then be in a position to return to the market after the anticipated correction. But stock prices and popular averages do not care how individual investors feel and perversely continue their general upward trend for the next two or so years following Mr. Bee’s portfolio liquidation. Mr. Bee is, of course, consistently kicking himself as time passes. Finally, he becomes convinced that he made a really bad decision two years ago and comes piling back into the market. And, of course, no sooner does he do so than a correction actually begins. Finally, near the market bottom, Mr. Bee, with a demoralized psyche and portfolio losses compounded by his attempts at market timing, sells everything, and of course, selling at the bottom limits Mr. Bee’s ability to recover any of his losses.
I have said more than once that on any given day in the history of modern economies, there have been a thousand reasons not to invest in equities. Today (the day I am writing this and the day you are reading this) is no different. Consider:
the country is in the midst of a severe health care crisis (of which the opioid epidemic and the obesity epidemic are representative instances) coupled with an outsized percentage of GDP devoted to health care, and no plan of comprehensive and affordable health care financing in sight;
we face severe deficits of every kind (federal and state budgets, trade, pension, Social Security, Medicare), which are more or less curable only with painful “adjustments” to taxes, social safety nets, retirement incomes and medical service provision;
our economy is increasingly characterized by material income inequality coupled with widespread income stagnation for millions of wage earners, which translates into continuing economic underperformance (recalling that consumer spending is a major driver of national economic performance, and hedged personal incomes translate into hedged consumer spending and thus hedged economic growth);
notwithstanding strong employment numbers, we have significant underemployment (meaning that a goodly percentage of employment growth is at wage levels down from the most recent period of high employment ... think all those new jobs in food service);
uncertainty reigns concerning future tax policy and future immigration policy (both of which are in some sense a proxy in part for very different ideas about what constitutes a “model” society and, therefore, how public policies should be crafted to realize, or not, the model in mind); and
You can add to the list. (Although, in doing so, you should not include the rise of economic nationalism and its partner, protectionism; at least in the United States. Despite some Kabuki-like head fakes, we believe the likelihood that any material protectionist legislation will materialize is zero to nil. About 48% of S&P 500 company sales are derived from non U.S. sources. (5) These companies, therefore, likely comprise impassable barriers to any serious protectionist impulses that might arise.)
Given this list (or the analogous list of real and supposed ills of past times, which would seldom have been shorter and often would have been much longer), one could be forgiven for asking, “is the market ever low enough to warrant investing in?”
Will Rogers said that making money in the market is easy. All you have to do is buy before a stock goes up and sell before it goes down. But somehow no one, at least no one we know (meaning me, you, investment professionals, day traders, etc.) can do this with any consistency. So one of the things we won’t do (and you shouldn’t either) is time the market.
What has always worked for us as an investment management philosophy can be summarized as follows: expect the best; prepare for the worst.
We hope for the best because we know, from our own considerable history and the history of investment management generally, that those who own good assets, appropriately diversified and held for the long term will generally prosper. This does not hold, by the way, for speculative positions bought and sold for the potential of short-term gains.
We prepare for the worst because there is always a disconnect between what is happening at any given time in the economy and what is happening at any given time in the lives of individuals and families. What does this mean in practice? We know that financial (and other) matters can go right, or wrong, in client lives at any time, without there being any necessary connection to economic or market conditions generally, and that it is our task as advisors to propose financial strategies that can be expected to maintain the integrity of client lives and well-being - come what may.
The existence of the disconnect between what you might call the macro and micro environment and how this disconnect is managed in client lives provides, I think, the best answer to the question “as my financial advisor/manager, what should you be doing, or are you doing, if the answer to the question ‘is the market high’ is yes, or even if the answer is maybe?” In fact, since we are always in the mode of expecting the best and preparing for the worst we should tack onto that question, “or even if the answer is no.” For it turns out that, given any particular economic environment, while we do make periodic adjustments on the margins, our fundamental financial advisory/management philosophy remains consistent.
A discussion of the nuts and bolts of our philosophy and how it works out in client lives would, I think, be of interest to readers of this newsletter, but I have managed to run out of space necessary to do it justice. No doubt, it will be a topic for a future newsletter.
1 For most of the portfolios we oversee we recommend allocation to securities of non-U.S. markets, which we believe are not generally among those that are now suspected of being ‘too high.’
2 At year-end 2016, U.S.-based mutual funds and exchange traded funds owned about $8.1 trillion in domestic equity. See https://www. statista.com/topics/1441/mutual-funds/. As the approximate total market cap of all domestic equity traded in the U.S. at the end of last year was about $25 trillion, https://seekingalpha.com/article/4040012-u-s- stock-market-tops-25-trillion- 1_9-trillion-since-election, this means that the portion of U.S. domestic equity in funds of one kind or another was about 32.4% of total domestic equity shares. The moral to the story is that there is some crude logic in thinking it’s okay to moosh it all together and treat it all as one. But it is crude, and can be very misleading as well.
3 Recall that what Greenspan referred to was “irrational” exuberance, and that he did so in December of 1996, in what turned out to be the run up to the dot.com bubble. But “the market” did not see a serious correction until more than three years later, toward the middle and end of 2000. And don’t forget: when that late 90s crash bottomed out in 2002, the S&P 500 was still higher than when Greenspan made his comments back in 1996. http://www.marketwatch.com/story/imf-chief-economist-says-maybe-financial-markets-are-in-midst-of-irrational-exuberance-2017-10-10.
4 There are more Millennials now than there were Baby Boomers in total, and the Millennials are beginning to ‘nest.’ See http://www.pewresearch.org/fact-tank/2016/04/25/millennials-overtake-baby-boomers/.
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Investment in mutual funds is also subject to market risk, investment style risk, investment adviser risk, market sector risk, equity securities risk, and portfolio turnover risks. More information about these risks and other risks can be found in the funds’ prospectus. You may obtain a prospectus for CWC's mutual funds by calling us toll-free at 800.355.9345 or visiting www.cweil.com. The prospectus should be read carefully before investing. CWC's mutual funds are distributed by Rafferty Capital Markets, LLC—Garden City, NY 11530. Nothing herein should be construed as legal or tax advice. You should consult an attorney or tax professional regarding your specific legal or tax situation. Christopher Weil & Company, Inc. may be contacted at 800.355.9345 or email@example.com.