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May 14 2019 Market Update

By on May 14 in Economics, Finance, Financial advisors, Market Update, Worth sharing

Is This Long-Term Rally Irrational?

The S&P 500 delivered 17.5 percent in total returns this year through April 30, 2019,[1] continuing robust performance from the first quarter.

The rally involved more than just stocks: for the year (through April), 89% of asset classes monitored by Deutsche Bank had positive total returns, a figure which includes bonds, credit, and commodities.[2]

We’ve had a swoon here and there, including the end of 2018 and once again last week on renewed trade tensions between the US and China. [3]

But it’s hard not to notice that equities have delivered strong returns for about a decade now. It raises a useful question: at what point does a rally become unsustainable – or even, dare we say it, irrational?

This isn’t simple to answer, especially because some of the key drivers of rising stock prices this year might surprise you.

In this month’s newsletter, we’ll look at some of those drivers, and how a long-term market rally should inform your long-term investment strategy.

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Do You Feel the Euphoria?

This might surprise you, but most investors aren’t beating down the doors to invest in the rally. In fact, statistics show that in 2019, there were more outflows from individual investors than inflows. By one analysis, $134 billion have flowed out of global equity mutual funds, with $56.4 drawn down from US mutual funds.[4]

One important reason is that a significant proportion of individual investors are retirees – and that number is expected to grow as more Baby Boomers retire. This means more people who are downshifting into more conservative strategies or drawing down their savings for income.

Other investors may be feeling a little nervous about the 10-year run of this bull market, preferring to cool their exposure to equities rather than double down. With the financial crisis just over a decade in the past, the feeling of wanting to play it at least somewhat safe might still be there.

In other words, this bull market still has a notable absence of “animal spirits,” or that sense of euphoria that is usually the hallmark of a rising bubble.

So What’s Pushing Up Prices?

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This time, prices are being pushed up by corporations. Share buybacks, the situation where a company purchases its own shares on the open market, have been a significant (and somewhat controversial) driver of the rally. And 2019 has been significant: share buybacks rose 22 percent in the first quarter of 2019.[5]

Is this a bad thing? It depends on who you ask.

Money that’s deployed to share repurchases isn’t spent on dividends or growth-generating investments in the future. That could be a concern if it means there aren’t enough productive uses for the cash that companies have amassed in recent years.

It could also mean that corporations are doing so well on a fundamental level that the cost of buybacks isn’t dangerous – even Berkshire Hathaway, which has historically avoided buying back its shares, is joining the trend.[6]

But some have argued that share buybacks push prices artificially high, and that when the buying stops, the market will fall.

Should We be Worried?

There are reasons to approach the situation with prudence.

Because corporations themselves are helping to drive stocks higher, there is an obvious question about why this is the most appropriate use of funds. Either they’re doing so well that they have cash to burn after investing in long-term projects and other growth-generating initiatives, or they don’t see a lot of worthwhile places to invest.

The former is arguably a good thing for investors; the latter, however, could spell trouble going forward a few years.

Another possibility, of course, is overconfidence, driven in part (possibly) by the availability of financing.

Something we’re paying attention to among publicly traded companies is leverage. As you likely remember from the financial crisis, heavy borrowing is an important risk factor for individuals and companies alike because it can significantly hamper the ability to maneuver when times get tough.

Corporate debt has reached significant levels. Corporate debt grew 20 percent in 2018, and the Federal Reserve recently issued a report warning about risks in the market as lending standards continue to fall.[7] As of November 2018, nonfinancial corporate debt topped $9 trillion, almost half of US gross domestic product.[8]

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Again, this isn’t an issue right now, but it does increase a company’s risks in the event of any headwinds or a downturn. Headwinds can include issues like higher costs due to trade barriers and uncertainty, a concern that’s very relevant right now as trade tensions between the US and China increase.

Combined with corporate demand for shares, we could see a situation where share prices tumble as a result of both lower corporate demand and sentiment in the event that the economic situation becomes more challenging for companies.

Stay Aware of Risks; Carry Out Your Plan

Right now, the economy is going strong and unemployment has hit its lowest point since 1969.[9] Despite the market’s reaction to the ongoing trade tensions with China, we don’t see a crisis around the corner, but we also don’t believe in the notion that markets will rise indefinitely or that there is no risk inherent in rising corporate debt.

We believe in discipline and in sticking with a strategy that can withstand any market – not just a rising one.

If you were with us back in 2008, you probably heard from our team that every calamity can present opportunities. We don’t recommend timing the market, but we do recommend creating a strategy that allows you the flexibility to make opportunistic moves where appropriate.

These are the types of strategies we build. The result is that you may not have captured the full 17.5 percent returns of the S&P 500 in your portfolio this year. Instead, you have a portfolio that can help you continue to capture opportunities throughout the market cycle, regardless of   corporate or investor sentiment.

Most people call this risk management. We just think of it as prudent investment management.

JSF Financial

 

 


Securities are offered through Mid Atlantic Capital Corporation (“MACC”) a registered broker dealer, Member FINRA/SIPC.
Investment advice is offered through JSF Financial, LLC, which is not a subsidiary or control affiliate of MACC.

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The information expressed herein are those of JSF Financial, LLC, it does not necessarily reflect the views of Mid Atlantic Capital Corporation (MACC). Neither JSF Financial LLC nor MACC gives tax or legal advice.  All opinions are subject to change without notice.  Neither the information provided, nor any opinion expressed constitutes a solicitation or recommendation for the purchase or sale of any security.  Investing involves risk, including possible loss of principal.  Indexes are unmanaged and cannot be invested in directly.

Historical data shown represents past performance and does not guarantee comparable future results.  The information and statistical data contained herein were obtained from sources believed to be reliable but in no way are guaranteed by JSF Financial, LLC or MACC as to accuracy or completeness. The information provided is not intended to be a complete analysis of every material fact respecting any strategy.  The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy. Diversification does not ensure a profit or guarantee against loss. Carefully consider the investment objectives, risks, charges and expenses of the trades referenced in this material before investing.

Asset Allocation and Diversification do not guarantee a profit or protect against a loss

The S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad stock market.

3-, 5-, and 10-year treasury notes are a debt obligation issued by the United States government that mature in 3-, 5-, or 10 years, respectively. Treasury notes pay interest at a fixed rate once every six months and pay the face value to the holder at maturity.

The Bloomberg Barclays U.S. Aggregate Bond Index measures the performance of the total U.S. investment-grade bond market. The index includes investment-grade U.S. Treasury bonds, government-related bonds, corporate bonds, mortgage-backed pass-through securities, commercial mortgage-backed securities and asset-backed securities that are publicly offered for sale in the United States.

The MSCI Emerging Markets Index consists of 24 countries representing 10% of world market capitalization.  The Index is available for a number of regions, market segments/sizes and covers approximately 85% of the free float-adjusted market capitalization in each of the 24 countries.

The MSCI Europe Index is part of the Modern Index Strategy and represents the performance of large and mid-cap equities across 15 developed countries in Europe. The Index has a number of sub-Indexes which cover various sub-regions market segments/sizes, sectors and covers approximately 85% of the free float-adjusted market capitalization in each country.  The MSCI World Index which is part of The Modern Index Strategy, is a broad global equity index that represents large and mid-cap equity performance across 23 developed markets countries. It covers approximately 85% of the free float-adjusted market capitalization in each country and MSCI World Index does not offer exposure to emerging markets.


Sources:
[1] http://performance.morningstar.com/Performance/index-c/performance-return.action?t=0P00001G7J&region=usa&culture=en-US
[2] https://www.wsj.com/articles/stocks-bonds-oil-bitcoin-are-all-up-the-everything-rally-is-back-worrying-some-investors-11557048630
[3] https://www.bloomberg.com/news/articles/2019-05-12/yen-advances-yuan-slips-as-trade-war-escalates-markets-wrap?srnd=premium
[4] https://www.bloomberg.com/news/articles/2019-05-03/the-u-s-stock-market-can-t-stop-won-t-stop-its-endless-rally?srnd=premium
[5] https://www.bloomberg.com/news/articles/2019-05-03/the-u-s-stock-market-can-t-stop-won-t-stop-its-endless-rally?srnd=premium
[6] https://www.bloomberg.com/news/articles/2019-05-04/berkshire-buys-back-more-stock-as-cash-pile-continues-to-grow
[7] https://www.bloomberg.com/news/articles/2019-05-06/fed-issues-more-warnings-on-hazards-of-high-risk-corporate-debt
[8] https://www.forbes.com/sites/greatspeculations/2019/04/08/what-ballooning-corporate-debt-means-for-investors/#28f330c1636c
[9] https://www.bloomberg.com/news/articles/2019-05-03/is-u-s-economy-solid-or-needing-rate-cut-jobs-data-back-both?srnd=premium

Performance table sources:
BBAB https://performance.morningstar.com/Performance/index-c/performance-return.action?t=XIUSA000MC
S&P 500 http://performance.morningstar.com/Performance/index-c/performance-return.action?t=0P00001G7J&region=usa&culture=en-US
MSCI World and EM https://www.msci.com/documents/10199/178e6643-6ae6-47b9-82be-e1fc565ededb
MSCI Europe https://www.msci.com/documents/10199/f6179af3-b1d1-4df0-8ac9-215451f3ac0a

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