U.S. stocks have been the best performing asset class in the world over the past three years with an average return of 16%, and we are currently on-track for a return above 20%. The DJIA has crossed over 22000 for the first time in history and has reached 33 closing records so far this year. There are plenty of reasons why the markets could be moving higher, but it’s extremely difficult to nail down what exactly is causing the push. Five of the most popular theories have to do with corporate earnings, monetary policy, passive investing, global outlook, and lack of other options.
The stock market’s trajectory is generally determined by the rate of earnings growth, and continuing strength from U.S. companies should push the market further. First quarter 2017 earnings were 15% higher than the previous year. As of August 11th, with 91% of the companies in the S&P 500 reporting Q2 results, 73% of the companies have reported positive EPS surprises and 69% have reported positive sales surprises. Second quarter earnings are projected to grow by double digits.
Interest rates play a large role in determining where an investor’s funds are funneled. Despite raising rates periodically, and indicating that they will do so again in the future, the Federal Reserve has chosen not to raise the Federal Funds Rate quickly. Low rates lessen incentives to invest in “safer” assets, like bonds or cash in a savings account. Without other attractive options, stocks look like the best option. The new business-friendly administration has been seen as good news for the corporate world. With talks of cutting taxes and loosening regulations, investors seem confident that companies will remain profitable in the near future. The DJIA experienced its second-fastest 20% gain following a presidential election based on the past 40 years. Hitting a 20% rise in 183 days is second only to the rise of 171 days, which occurred after George H.W. Bush was elected in 1988. These can be compared to 308 days for Bill Clinton in 1992, 537 for Barack Obama in 2008, 586 for Ronald Reagan in 1980, 1,626 for George W. Bush in 2000, and 1,630 for Jimmy Carter in 1976.
Global growth is generally projected to pick up. Despite plow horse growth in the U.S., the rest of the world seems to be heading into areas of strong growth. Both large multi-national companies and foreign-oriented funds are expected to benefit most from this steady growth and weaker dollar. Companies in the SP500 get nearly 30% of their revenue overseas, and a weaker dollar has further increased profits. The International Monetary Fund sees global growth staying steady through the end of next year. There are of course risks, Europe’s political calm could end or China’s debt bubble could burst. There’s also geopolitical risks with Russia, Iran, Syria, North Korea or China.
With such a steady track record of growth, our current market is very interesting. We are currently experiencing very low volatility. The CBOE Volatility Index recently closed at its lowest since 1993. Also, so far this year we have not experienced a decline of even 5% from the previous high. The Wall Street Journal recently reported that three major stock-market benchmarks: the U.S., Europe and Asia have avoided pullbacks this year. Never in the past 30 years have all three indexes (the S&P 500, MSCI Europe, and MSCI Asia-Pacific ex-Japan) gone a calendar year without falling at some point by at least 5%.
Markets have continued to reach all-time highs, lengthening what is currently the second-longest bull market in U.S. history. Surely this growth can’t be sustained for long, right?
The answer…it might! Even though closing in on the longest growth streak in our history (10 years) has made some investors anxious, the growth isn’t unsupported. The most recent catalyst is projections in global earnings growth. Global corporate earnings have beaten estimates driving markets higher than anticipated. According to reports from Blackrock, the ratio of analysts revising their global earnings estimates higher rather than lower recently jumped to its highest level in about five years.
So, what are the markets actually at right now? All three major U.S. stock market indices are currently at all-time highs. As of July 21st 2017, the DJIA is above 21,000 after returning 10.67% YTD, the S&P 500 is above 2400 after returning 11.67% YTD, and the Nasdaq is above 6410 after returning 22.495 YTD. The market also has very low volatility. The CBOE Volatility Index recently closed at its lowest since 1993. Also, so far this year we have not experienced a decline of even 5% from the previous high. The Wall Street Journal recently reported that three major stock-market benchmarks: the U.S., Europe and Asia have avoided pullbacks this year. Never in the past 30 years have all three indexes (the S&P 500, MSCI Europe, and MSCI Asia-Pacific ex-Japan) gone a calendar year without falling at some point by at least 5%.
While the market’s growth has been strong and steady, it wouldn’t be unusual to experience a correction at some point. In fact, with corrections normally occurring at a rate of about one or two per year, it would actually be more unusual to not have a correction. Corrections are defined as market decreases of around 10% (compared to decreases of 20% or more for bear markets) and are natural phenomenon of healthy markets.
Even so, plenty of investors might think they’ll be able to sit on the sidelines with their cash and jump in when the correction brings the market to its lowest. But in reality, market timing on average doesn’t work. It actually turns out that the market makes most of its gains for the year during a handful of days. For example, if you were invested in the S&P 500 Index from 1993 to 2013, you would have earned about 9.22% per year. But if you removed the 20 best days during that 20-year period, your return would end up at about 3.02% each year.
So what advice would I give to investors worried about market declines? I would encourage them to accept corrections as a normal part of investing. If you are in retirement, I would also look at my portfolio from an income standpoint, not just growth. If you can switch your focus to how much the portfolio is creating in income, it makes market fluctuations much easier to live through. Currently a well-diversified portfolio of stocks and bonds is creating anywhere between 4 to 6% in income. That goes a long way to helping you continue to receive an income and yet not require you to sell shares when prices are temporarily lower.
Can markets go further? Despite market highs, most analyst feel the economy is fundamentally strong and therefore do not see a full Bear market or a recession in the near future. In addition, earnings power of companies is another indicator that the market could continue to move higher. In 2008, S&P500 earnings were $49.50 and next year they could triple to $145 to $146 per share according to Jeffrey Saut, Chief Investment strategist at Raymond James. Investment news May 22, 2017.
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