Pump the Brakes

The only fear on Wall Street today seems to be the fear of missing out. F.O.M.O. for short.

The markets have been ripping for more than two years now. And, aside from a few brief moments of volatility, it’s been a strong move up and to the right.

This has pushed the S&P 500 to record high after record high.

This has pushed the S&P 500 to record high after record high.

The surge has come in the face of fears of an economic slowdown caused by higher interest rates and wars around the world.

But, people can only stay scared for so long. Eventually, it becomes the boy who cried wolf. And, for the markets, fears of a recession never materialized. So, the market turned to different stories.

The ascendance of artificial intelligence became an easy one to catch the market’s attention. AI delivers the promise of growing productivity, which should boost profits. So, that’s been a major force pushing the market higher.

The ascendance of artificial intelligence became an easy one to catch the market’s attention.

As advisors, our job is to help you figure out where it’s going from here. To be sure, it’s a fool’s errand to try and make precise calls. So, that’s not what we’re going to do. Instead we’re going to focus on history and the current conditions to help guide our thinking.

History tells us the markets generally produce about 10-11% returns annually . The S&P 500 has vastly outperformed that since the Great Financial Crisis.

We also know markets generally turn bullish when conditions are bad—high unemployment, recession, etc.

We also know markets generally turn bullish when conditions are bad—high unemployment, recession, etc.

In this case 2022 is an outlier over the last 30 years. The bull market started when continuing jobless claims were bottoming, not topping.

It seems the pandemic had a role to play here. First, I’ve read reports recently where some unemployed people did not think they qualified for benefits during a stretch in 2022 so they didn’t apply.

But, the bigger story in my mind is the money supply. The U.S. inflated the money supply by around 40% in response to the pandemic. Globally, you can see in the chart below, the money supply increased by some 24%. That’s far greater than pre-pandemic norms.

But, the bigger story in my mind is the money supply.

That increased supply of money provided juice to boost the price of everything from goods and services, to asset prices like stocks and real estate. Think about how much the price of your home has soared in recent years.

The big question has been: how long before that excess cash will be exhausted, and we’ll be back on trend?

It likely would have already happened, but more money was injected into the system following the collapse of Silicon Valley Bank in the Spring of 2023. So, normalcy was delayed.

It likely would have already happened, but more money was injected into the system following the collapse of Silicon Valley Bank in the Spring of 2023.

Now, look at pricing. The U.S. market trades at a high premium whether you’re looking at the aggregate value of the market’s earnings, cash or assets.

Markets can stay elevated for some time. Look at the late 90s for proof. But, over the long-term, valuations matter immensely.

What does all of this mean?

What does all of this mean?

In short, pump the brakes.

The markets have given investors greater returns than normal in recent years thanks to artificially low interest rates during the 2010’s. That was followed on by massive stimulus post-Covid.

Now, artificial intelligence could deliver on its promise in short order and that could justify the market’s momentum well into the future. That’s the bull case.

Now, artificial intelligence could deliver on its promise in short order and that could justify the market’s momentum well into the future.

The bears would argue that high valuations, higher interest rates and less stimulus will eventually become a drag for investors.

Here’s how we think about it: You’d be wise to balance the risks by getting the appropriate mix of assets into your portfolio. That means having the right mix between stocks, bonds and cash.

It also means having the right mix within your stock portfolio—balancing the high-growth companies that can be pricier with those boring businesses that deliver more reliable returns, albeit at a somewhat pedestrian pace.

It also means having the right mix within your stock portfolio—balancing the high-growth companies that can be pricier with those boring businesses that deliver more reliable returns, albeit at a somewhat pedestrian pace.

The real key in either case is being able to justify the price you’re paying for each company’s earnings.

The market is a funny animal. You can’t predict where it’s headed over the coming weeks or months. Or even the the next year or two. But, it’s wise to consider Warren Buffett’s advice:

“To be fearful when others are greedy, and to be greedy only when others are fearful.”

“To be fearful when others are greedy, and to be greedy only when others are fearful.

That argues for prudence and discipline. And, that’s how we try to help clients navigate their money and their future.

This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.

All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC.