For most investors, the risks to the stock market are rarely discussed. Here is my view of the risk to investors in the coming years.
So here we are at Dow 22,000.
Let’s review how we got here: the financial experts predicted a stock market crash if Brexit passed. It did and investors shrugged it off. Then the stock market strategists warned us that if Donald Trump was elected, the stock market would crash. The market has since rallied 12-15% to new highs in every index. Even cyber currencies like bitcoin and etherium are at new highs. And here we are.
Most mutual fund managers were underinvested heading into the election. Since Trump’s improbable win, professional investors have been playing catch up- trying to get invested in a stock market that has not fallen by more than 1% on any day for a month- something that hasn’t happened in 54 years. This applies to the S&P 500 as well as the Dow Jones Industrial Average. Volatility has been crushed.
Stock Valuations are very stretched. Depending on the figure, we are at near 26X earnings on the S&P 500. Levels last seen in 1929, 1999, and 2008. This means the market is expensive. However, due to the intervention by the Federal Reserve in the bond market, the stock market is viewed as the only alternative for most investors. This is a very unnatural situation. As a value investor, I can tell you there are hardly any stocks that fit my strict criteria. Very few stocks are undervalued.
The risk is not a crash. The real risk is that 7-10 years from now, we are still at or below 2400 on the S&P 500 or 21,000 on the Dow Jones Average.
Why? The fed has used emergency level interest rates going on 7 years. This was used to stimulate the economy. The federal reserve has a $4B balance sheet. Interest rates have been at historic lows. This has boosted stocks and real estate artificially. Pulling future gains to the present. If we have taken future returns, then future returns should be lower going forward. The fed has been artificially supporting the market. We don’t know what will happen when they unwind their balance sheet and rates return to normal levels.
When I ran this morning, I cheated a little bit. After I ran, I was walking on the treadmill, but was holding on to the side rails. It’s cheating. My arms were supporting my body. That’s what the fed actions and the stock buybacks have created. It’s artificial support.
Are companies doing well? Not really. They’re shrinking their shares outstanding by buying back stock. Where does the money come from? Mostly from issuing bonds aided by low interest rates.
Buybacks used to be done exclusively by companies that felt their shares were undervalued by investors. Today, almost every major buyback is being done at all time highs. Think about that. “Were buying back our stock because it’s undervalued … at All Time Highs!”
I’m not impressed.
There is a big difference between running 5 miles and walking 5 miles holding the side rails of a treadmill. This market has been sustained for far too long with artificial support. I’m cautious and skeptical.
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