Since we’re nearly 5 years removed from the bottom that the S&P 500 index set on March 9, 2009, it’s probably a good time to reexamine where we are and whether or not we’re looking at a possible correction again. Of course, everyone has their own opinion on this and at this point it IS just OPINIONS. But facts (or lack of facts) usually back up a person’s opinions, so let’s try looking at some of the facts and see how those opinions are formed.
First, let’s look at the positives. The economy looks to be growing, albeit slowly. Total retail sales in the USA in calendar year 2013 were $5.085 trillion, up +4.2% from its total in 2012, according to Michael A. Higley’s “By the Numbers” 2/24/14 newsletter. The early February Federal Reserve meeting, the Fed committed to continuing the reduction in bond purchases, with an additional $10 billion reduction in quantitative easing bond purchases. That could indicate the Federal Reserve believes the economy is getting stronger. Their language about conditions and business/consumer spending was generally more optimistic.
The STOXX Europe 600 Index posted a third straight week of gains and climbed to its highest level in six years. News about the Eurozone economic recovery has turned increasingly positive. And with earnings season nearly over, S&P Dow Jones Indices says it’s likely that fourth-quarter 2013 earnings for S&P 500 companies will break a record, as they did in each of the preceding three quarters of 2013. This is a little deceiving, however, as I’ll explain shortly.
John Hancock’s most recent Viewpoints newsletter trumpets “Bias towards higher equity prices remain.” Mark Donovan, CFA, says that “at around 1,800, the S&P 500 Index trades at about 16.5 times estimated 2013 earnings,” and as such, “the equity markets look neither cheap nor overvalued.”
So is there anything to worry about?
Some others see some negative factors. LSA Portfolio Analytics sends us their weekly investment committee minutes. They noted many economic indicators came in weaker than expected in February: Empire manufacturing survey, the Philadelphia Fed manufacturing index, the NAHB housing market index. Housing starts for January fell -16.0% and building permits also lost ground, falling -5.4% compared to an expected decline of -1.6%.
Noted economist Harry Dent, who studies the world’s demographic trends as a predictor of future economic trends, thinks we are in a bubble that will burst soon. He cites the fact that margin debt – borrowing money to buy investments, is approaching the high of 2007. Stock buybacks are reaching very high levels as well, as 83% of the S&P 500 companies are buying back their shares compared to 87% in 2007. Stock buybacks artificially inflate earnings per share and can give the illusion that a company’s earnings are growing when they may not be; if a company for instance has $10 of earnings and 10 shares outstanding, that’s $1 of earnings/share. If they buy back 4 shares, now there’s only 6 shares outstanding, so the earnings per share goes up from $1/share to $1.67/share ($10 of earnings/6 shares) even though the earnings themselves did not change.
As for the market itself, since 2000 each successive major correction has only gotten greater. The 2000-2002 crash was nearly a 50% drop in the S&P 500, the 2007-2009 drop was over 55%. If the market drops to that same general level of support as in 2002 and 2009, the drop will be over 63%. Although there are a few exceptions, most bull markets don’t last much longer than 5 years!
While we are not predicting such a drop, we also would not rule it out. Given that anything is possible, we have been suggesting it would be worthwhile to stress test your portfolio against potential negative outcomes.
The Federal Reserve, Wall Street banks and other major hedge funds use stress testing to project their losses in the event of the unexpected. Stress testing is a routine part of our process.
We start by asking questions like, “Historically, what happened to this group of investments when the dollar crashes, the economy falls into recession/depression, or oil prices skyrocket?” We model over 60 scenarios – both positive and negative.
Our model measures the potential impact of these scenarios on investments using history as a guide, providing insight into the historical characteristics of portfolios.
The software then uses this data to project how your investments might react to future scenarios, both positive and negative. When running a stress test, each investment in your portfolio can be tested against 60+ scenarios in this manner, with the results combined and summarized for easy understanding.
You can see how the stress test works by going to www.cfgiowa.com and click on the “Take Your Free Stress Test” button on the home page.
Investing involves risk including loss of principal.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.