Howestreet.com - the source for market opinions

ALWAYS CONSULT YOUR INVESTMENT PROFESSIONAL BEFORE MAKING ANY INVESTMENT DECISION

January 14, 2018 | Emotion

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

Fear and greed move markets. Emotions stronger than sex. Or blog addiction. Greed made people buy Bitcoin when it approached twenty thousand. That was stupid. Fear made people sell stocks in 2009. Utterly dumb. Greed spurred big sales of ‘investment’ condos that lose money. Fear of missing out propelled houses last spring. Regret now. Lately greedy investors have piled into equity markets because they’re roaring. Others are recoiling for the same reason, fearful of collapse.

On the weekend one of my fancy-pants portfolio manager colleagues said shunning markets simply because they’re high is irrational. Some posters responded by saying we’re on the cusp of 1929. Others pointed out if houses inflate and are now dangerous, why don’t we apply the same logic to financial markets?

Predictions are hard to make, especially when they involve the future. But it’s easy to see the correlation between residential real estate values, household debt and interest rates. Rates go down, debt and prices rise. When rates reverse and begin to normalize, it gets worse – house prices drop but the debt remains. Household budgets squish like a grape.

Stocks benefit from low rates, too. Bonds get more expensive and yields drop. So money flows into equities where returns are far better. Meanwhile cheap money allows companies to borrow to expand, finance takeovers or stock buybacks which inflate equity values. The key difference, however, is that stock markets also – and primarily – reflect the value of real and potential revenue growth. The more companies earn, the more they’re worth. The stock rises in value. Additionally, the more potential investors see for growth and profits, the more they are willing to pay now to get a piece of it. (Talking about you, Tesla…)

Lately central banks have been restoring rates. The Fed has increased four times in about a year. The Bank of Canada will probably jump its rate on Wednesday, the third time in half a year. The experts say we have at least two more years of this ahead of us.

As a result, real estate is being impacted and more wobbles lie ahead. Equities, in contrast, are roaring. The Dow hit 70 new highs last year, increased 25%, and is off to a rabbit start in 2018. To stock investors, rate increases signal economic expansion since central bankers feel they can withdraw the stimulus that’s been in place for almost a decade. The world economy will grow at 4% this year, compared to 0% a few years ago. Unemployment in the US is now full employment. Canada created more jobs in the last 90 days than in any three-month period in decades. Rates are rising in order to moderate growth, contain inflation, temper wage demands and cool price increases. In this world, stocks win and houses lose.

But what of this 1929 buzz? Will equity markets crash just because they are high?

The Dow over the past 100 years.

As my PM bud said, that’s illogical. Over time stocks rise almost 80% of the time, because they pace growth, expansion and prosperity. If economies are in trouble, unemployment is raging and living standards falling, equities will, too. But that’s not today. Or in the foreseeable future. And it certainly is not 1929. Not even 2007. Not even close.

Nonetheless, they’re now using the term “melt-up” to describe what’s happening on Wall Street – a rally made stronger by investors who fear missing further gains. There are estimates that despite a 25% romp last year, 2018 will bring a double-digit advance. The market may even be 30% or more from a top, at which point it will correct, stabilize, then go higher – if history is any guide.

Reasons are clear. Corporate profits are expected to advance 15% this year. That’s huge. The US just cut corporate taxes from 35% to 21% – and the impact is not even yet being felt. American unemployment is at a 40-year low. Commodity prices have rebounded along with demand. Credit markets are robust despite rising rates. Consumer and business confidence are at record levels.

However, are stocks too high relative to profits? The Shiller P/E (price-to-earnings ratio), yardstick, which many doomers follow, is flashing red. But by using 10 years of earnings to arrive at its level, that index is flawed, since corporate revenues collapsed during the credit crisis. Other measures show stocks at a far less elevated point by historic standards.

Naturally, there are risks. CBs may get it wrong, allow inflation to ramp up then respond with big rate hikes, killing the economy. Rocket man might do the unthinkable. Trump, too. Protectionism, tribalism and the politics of division could derail global growth. Weather events are getting costly and extreme. There is terrorism to worry about, plus Oprah.

Expect corrections. The higher things go the more reversals will be felt. But corrections are not crashes. They don’t last long (the average is 17 weeks) and if you have a balanced portfolio, the safe stuff increases in value when the growth assets decline. People with balance in 2008-9 (who didn’t panic and sell) cruised right through an event of generational proportion.

So be scared if you want. But that would be a waste. There are far better places to channel all that emotion.

STAY INFORMED! Receive our Weekly Recap of thought provoking articles, podcasts, and radio delivered to your inbox for FREE! Sign up here for the HoweStreet.com Weekly Recap.

January 14th, 2018

Posted In: The Greater Fool

Post a Comment:

Your email address will not be published. Required fields are marked *

All Comments are moderated before appearing on the site

*
*

This site uses Akismet to reduce spam. Learn how your comment data is processed.