Investor Discussions - Is This Market Too High?

Wealth & Pension Services Group
William Kring, CFP, AIF - Chief Investment Officer
06/27/2017

Is This Market Too High? 

I opened up Morningstar on my PC this morning, and there was the headline - "Is this market too high?".  I've heard that from some clients lately, plus you've likely heard statements recently like, "the market is overpriced," "the market is due for a correction," and, "should we sell and go to cash?" 

As I'm sure you know, it is certainly more complicated than these simple questions or statements pretend. You may remember a couple of pieces I wrote about profits at the end of last year along with a follow-up at the beginning of this year. I talked about how the market usually focuses on profits (amid all of the noise) and that this year I was expecting profits to rise. So far corporate profits are coming in fine, and we've had a good year; if it could always be so simple.

So now, rather than answering the question, is the market too high?  Ask instead, can profits continue to keep climbing?  To answer that, we need to know if there is enough slack in the labor market. We should wonder is there enough pricing power left for companies,  are consumers still willing to spend, will rates stay low enough, and will technology continue to help business ring efficiencies from their businesses? I think, for the most part, the answer to these questions is yes.

So, if we can expect more profits, what does that say about valuations?  Surely, at some point, the market will get too expensive. By some measures, it is already expensive. However, when discussing valuations, it helps to use some context. For instance, valuations may be high, but compared to what other situations? Compared to a time when interest rates were much higher, with the potential to stifle growth? Or now, with low interest rates. Compared to a time when growth was slowing?  Or now, when growth is still present. Don't get me wrong; the market will fall - maybe soon- but I think it will be short-lived and we can have one more run. 

Here's an interesting fact if you are feeling unsure.  Since 1980 the average annual return for the S&P 500 was positive 8.5%. Source:  JP Morgan Guide to the Markets.  During those 37 years, the average intra-year drop was just over 14%. That included a time when annual returns were positive in 28 out of 37 years.  Bottom line, markets correct in most years, even when the year turns out positive. I'm reading your mind here- no, we cannot time the drops! 

If we could pick out one conundrum right now, it might be the fact that the bond market is not going along with the pro-growth story.  Rates are once again low (giving everyone one more time to re-finance).   One possible explanation for low rates is foreign demand for our treasuries because our rates are still much higher than other developed countries.  Either way, I'm willing to dismiss our low rates as something to cause worry at this time.  For a bit longer term worries, we will keep our eye on a slowing economy, recession, or a big tick-up in rates as the next big thing. But, for now, we are inclined to keep sticking with this market. We are using core bonds as a backstop, spreading some money internationally, and underweighting the most expensive stocks and overweighting value stocks. Using this approach, we feel we can get an adequate return staying invested at these levels, even while expecting a correction.    As always, your circumstances and risk tolerances are important to me, so please don't hesitate to call if you have any questions or concerns.

 William Kring, CFP^®, AIF^®