Is the Stock Market Too High?
We separate the relevant from the noise, to bring you timely content that helps you on the path to and through retirement!
This month’s newsletter starts off with an update on the economy and the stock market. We then move on to the exciting innovations we’re in the midst of today, the shrinking supply of stocks, and something you should pay attention to in your portfolio – allocation drift. Finally, we wrap up with a discussion on fiduciaries and why you should care.
State of the Markets – S&P 500: 2,818.37 (+5.4% YTD through 8/15/18)
The S&P 500 Index has rallied five straight weeks and is within a whisper of its all-time high reached in January 2018. Second quarter sales have been stellar. Consumer & business confidence remains strong and volatility is at its lowest level in 2018. Many investors are fearful that the stock market is too high, but the fundamentals tell us otherwise. We believe current stock prices are justified by strong sales, earnings, & GDP growth.
GDP grew at a 4.1% annualized rate in the 2nd quarter, boosting the prospects that the economy will continue to gain momentum. Consumer spending and business investment has also surged. According to FactSet, the current U.S. economic expansion is now the second longest in post-war history, at 108 months so far (120 months is the record from 1991-2001).
Larry Kudlow has famously said, “Earnings are the mother’s milk of stocks”. According to FactSet, S&P 500 earnings grew 24.8% in the 1st quarter of 2018, which was the highest % earnings growth since 2010. 2nd quarter earnings are up 21.2% (2nd highest % growth since 2010), and for the rest of the year, earnings are expected to grow 20%. Most of the increase is due to tax cuts but continued deregulation is also helping.
What’s especially interesting is that investors are dumping stocks! Nearly $20 billion flowed out of stocks in June and $55 billion fled stocks during the first half of 2018 [1]. With the painful memories of the Great Recession still fresh, investors continue to doubt the stock market’s sustainability and are looking for any excuse to pocket gains.
Bottom line: The current stock market and economic expansion are stretching the historical norms, but we still see further growth ahead.
Innovation Explosion
The late 1800s saw unprecedented innovation that changed the world! The telephone, telegraph, electricity, electric lights, combustible engines, elevators, steel, oil, rubber, and photographs were all brought to life during this innovation explosion of the late 1800s. These innovations created tremendous wealth for those with money to invest and the foresight to understand how the applications of these inventions would change the world.
Today we are seeing similar innovations in many industries. The iPhone has only been around since 2008, yet it impacts virtually every aspect of our lives. And who would have dreamed that 10 years ago companies would be mass-producing electric and autonomous cars?
Artificial Intelligence is everywhere! Many of us use Siri and Alexa to tell us how to get to a restaurant, settle a debate, or play a song. 3D printing has huge potential to change our lives in the coming years. There are also advancements being made in genetics and healthcare. These innovations are improving the world’s standard of living and in certain circumstances providing rare and exciting investment opportunities. The hard part is visualizing the market potential and picking the winners.
Shrinking Supply is Helping the U.S. Stock Market
The broadest measure of stock market value is the Wilshire Index, which was established in 1974 and gradually grew to a peak headcount of 7,562 companies in 1998. As of December 31, 2017, the index contained only 3,492 companies as privatization and mergers far outstripped new IPOs. Thus, over the last two decades, more than half of the supply of companies in the Wilshire Index has vanished.
According to David Kostin, U.S. Equity Strategist at Goldman Sachs, “U.S. companies appear poised to eclipse the $1 trillion mark in share buybacks this year, a pivotal record that will keep the stock market going even as many retail investors are beginning to fear equities”.
Also helping to shrink the supply of stock is the record amount of buyback activity. Through the 1st quarter of 2018, U.S. corporations set a record for most shares re-purchased of $189.1 billion – a 38% increase from the previous quarter [2]. These buyback decisions reduce the number of shares outstanding and increase the relative value of the remaining shares.
Beware of Allocation Drift
One thing we’ve been watching closely over the last couple years is something called “allocation drift” in client portfolios. As the stock market keeps marching upward, the percentage in stocks tends to climb higher. This can happen in both individual stocks, funds, or ETFs, as well as the entire stock portfolio.
Amazingly, the S&P 500 has rallied 326% since the market lows in 2009, and these gains may have caused your stock & bond allocation to drift – quite significantly.
The result is you may have many more assets in the stock market than is appropriate given your risk tolerance, age, and income needs. We keep a close watch on this, but it may be tempting to continue to let your portfolio drift in good times. It’s important to be disciplined and to reduce your position in stocks while the market is moving higher if it makes sense to do so and if your asset allocation has drifted too far.
When the next major market downturn arrives, you’ll likely be glad that you re-allocated your portfolio to get back to your “target” level while the market was still on the upswing.
What Does Fiduciary Really Mean?
I was speaking to a client the other day who finally understood what it meant for our firm to be a fee-only, fiduciary advisory firm. Then he exclaimed: “Why aren’t you telling more people about this?!” We thought it was a good point, and while some of you might know the story of what led to the choice we made when starting our own firm, most clients still don’t fully understand what “fee-only” and “fiduciary” mean and why it matters.
So, what does it mean to be a “fee-only” financial advisor? It means that as an advisor, we don’t accept commissions, kickbacks or other perks from selling certain products. The only compensation received is directly from the client.
This is an important (and rare!) distinction in the world of financial advice. When an advisor is truly fee-only, there is a fiduciary obligation to do what is in the best interest of the client and to put the client’s interests first.
In 2015, when CNBC released its second annual list of the “Top 100 Fee-Only Wealth Management Firms” it noted that consumers should “make sure you understand how that [advisor] gets paid, and that means [understanding] fees vs commissions” and that “fee-only financial planners… do not accept any commissions or other compensation based on product sales.”
But in a bit of an embarrassing blunder, even the list creators themselves didn’t understand their own criteria, since a deeper look at the ADV (disclosure document) for 9 out of the top 10 firms on their list revealed that these firms were not fee-only!
We point this out because the Registered Investment Advisor (RIA) business model that we chose was very intentional since it affords us the rare distinction of being truly fee-only and beholden to the interest of our clients ahead of our own, in all circumstances.
