In case you missed it, both the Dow Jones Industrial Average and the S&P 500 Index climbed to new all-time highs last week. Lately that seems to be the headline every week, if not every other day. A common question investors are asking, given the increase in the market over a short period of time, is “Is the market in a bubble, and how do we react if it is?” The S&P was up more than 12% in 2016 and it is currently up more than 9% this year, and it is only June.
First, a bubble occurs when investors drive up the price of an asset at a sharp and sustained pace, beyond a reflection of what it is worth. In 2007, we saw a Housing bubble when home prices reached their peak, fueled by banks lowering their lending standards. In the early 2000s, we saw a Technology bubble when every dot-com business was trading sky-high, but had no earnings or revenue to justify those valuations.
If you look at the fundamentals of our current market, earnings were up 15% in first quarter 2017; leverage is in check, and company cash flows are strong. The market is generally forward looking, which indicates investors believe earnings and revenue will continue to grow. We don’t see any clear signs of a bubble. The Technology sector has been leading the market, but the leading companies have earnings growth. Seven of the top 10 earners in the S&P 500, weighted by average return, are technology companies.
Volatility, as measured by the Chicago Board Options Exchange Volatility Index, has been light for some time now. Any recent spikes appear to be politically driven, not driven by economic data points that have missed expectations. The low volatility could be a byproduct of algorithmic trading, or it could be investors increasing in passive trading, meaning they’re just investing in products that track the major indices. These investors aren’t selling as market conditions change because they are passive.
While many market pundits say we are well overdue for a 10% correction, the market is not likely to correct itself without an economic catalyst. Current fundamentals are intact: The yield curve isn’t inverted; credit spreads are tight; unemployment is low; and consumer comfort is high.
As an investor, if you’re asking if we are in a bubble, what you’re really asking is can you time the market? Can you get out before the bubble bursts, and then get back in to reap the gains of the next recovery? Market timing is nearly impossible because none of us know what the stock market will do next in the short run.
If a bubble is still your concern, it may be time to review your risk appetite, and make sure your financial plan makes sense for you. If risk is what is bothering you, your adviser should look at your risk profile and maybe consider some less risky investments that do not correlate to the market swings. Now is also a great time to rebalance. Rebalancing your portfolio to your intended sector allocation will reduce your exposure to Technology, which has outperformed, decreasing your risk.
There will likely never be a time that we would say to go to all cash. Remember, we work with a 10 year rule, money needed within the next 10 years for your spending needs should be in fixed-income investments to preserve principal. Any money not needed in 10 years should be invested in high quality equities. We believe investing in stocks is one of the few ways you can beat inflation over time.
If you have questions regarding how your investments work with your overall financial plan, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
