Are Asset Prices Set to Collapse?

Chip Corley  |

via GIPHY

Stock investors, real estate moguls, speculators and gamblers alike are feeling noticeably skittish. Why? Since the financial crisis ended and the stock market bottomed on March 3rd,2009, asset prices have sustained the second most extended bull market since World War II. The duration of this secular bull market is 110 months. So far in 2018, the S&P 500 posted 14 record highs, all in the month of January, its most ever. The index has recorded a total of 202 all-time highs over the course of this 9 year bull market run; this is double the historical mean. For many investors, soothsayers, and especially news providers, the stock market’s valuation is a grave concern. Some so-called experts are espousing that we are witnessing a generational bubble that will soon pop, and the effects will be far direr than previous cycles.

The secular bull market of ’09 is the twelfth since the ending of the Second World War. The average performance gain, and duration, of all bull markets during this time frame has been 150%, and 4.8 years, respectively. As counterweight, there have been an equal number of bear markets that have registered average losses of 32% and endured 14 months. CNN Money’s Fear & Greed Index below measures the state of investor emotions on a scale of 1 to 100. It is now at 11 and registering extreme fear; at this level, it is the lowest the index reading has been in multiple years. This behavioral stance is contrary to typical market tops; bull markets are mostly born on pessimism and usually die on extreme optimism. The psychology vibe at the moment feels less than enthusiastic.

The headline worries unraveling investors nerves and triggering stock price selloffs are as follows:

  • Rising Rates: When it comes to making money in the stock market, it is wise to keep a close eye on the Fed. The Federal Reserve has transitioned from a decade stance of easy money to one less so. The Fed’s objective is to keep inflation in check. To accomplish this aim, the Fed raises short-term interest rates and releases policy statements. The Fed’s mandate is to maximize employment and maintain price stability. The U.S. economy is consumer-centric. Consumer expenditures make up two-thirds of the U.S. economy; as interest rates climb, consumer spending gets squeezed. As the expense from borrowing escalates, it limits the amount that buyers can afford to spend on large purchases like homes and cars. Credit cards and revolving lines of credit have variable interest rates that fluctuate in line with the prime rate, which has risen from 3.25% to 4.58%. Federal student loans are set annually according to the 10-year treasury note, which is up to 2.8% from 1.4%.
  • Tariff Threats: There are mounting concerns over the United States-China trade relationship. I have read headlines citing risk of potential trade wars. I am not a big fan of protectionist policies. Free market capitalism advocates the unencumbered exchange of products and services at prevailing market prices. Free markets catalyze innovation, improve product quality, and govern price pressures. Tariffs are defacto tax hikes that are regressive on low-income families. History reflects that the Smoot-Hawley Tariff of 1929, Nixon’s 10 percent surcharge, and Bush’s steel tariffs did not work as planned, and stock prices suffered; lest I say more.
  • Valuation Variances: The S&P 500 is currently priced at a 26 P/E ratio based on its trailing 12 month earnings, and valued 38% above its 30 year average P/E of 18.8; the spread differential is substantial. Are stocks really trading nearly 40% above their norms? The “for profit” media reports that financial assets are notoriously expensive and due for a correction. Investors are bombarded by “alleged factual” rhetoric and are jittery that they could lose 40% of their money if stock prices retrace to their norm. Well, there is another side to this argument; the reality is that financial markets are forward-looking, not backward. S&P 500 operating earnings estimates for the year ahead are forecasted to be $160.09 per share.At current levels, the S&P 500 is trading at 16.6 times 12 month forward earnings; this is 7% below its 30 year average of 18 P/E.

The Maven of Manhattan, Sam Stovall, informs astute listeners, “Bull markets do not die of old age, they die of fear, and what they are most afraid of is a recession.” A recession connotes a marked slump in economic activity reflected in employment, personal income, industrial production, and GDP growth. Economists identify recessions when there are two consecutive quarters of GDP contraction. The long-term annual return for stocks has been 10%; during recession periods the results have been -4%. As denoted in the following chart, since Q1-2014, the U.S. economy has continued its expansion.

Corporate earnings growth is a byproduct of GDP growth. Corporate profits are at record levels, and the Tax Cut and Jobs Act is just kicking into gear.

The employment situation is optimal. Civilian unemployment is at 4.1%, and job growth has averaged 208,000 per month the past five years while inflation remains tame. The shortage of qualified workers is a headwind to employment growth.

Personal income growth remains anchored in the low single digits, and yet, as the labor market tightens from lack of workers, incomes are poised to increase. I reiterate that the consumer is the driving force behind our economic growth. The more money that flows to working folks makes for better standards of living.

We are nearing the time of year when stock performance has traditionally waned. Since 1950, the six month period I aptly call the Sour Six has posted a scant 0.3% return for investors in price appreciation and has faired even worse during the mid-year presidential cycle. Stocks are known to climb a wall of worry. In the months to follow, there may be an opportunity to add quality stocks at bargain prices.

—William “Chip” Corley

Author of Financial Fitness: The Journey from Wall Street to Badwater 135


DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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