State of the Union – September 2019

It’s been awhile since we’ve done a market update, and since we’ve started to notice a little concern creeping into our client communications, it’s a good sign there is some small, yet growing concern.

First, let’s start with some market data to cut through a little bit of the noise as well as some facts about where we are in historical context.

    • Price
      • Since January of 2018 (18 months ago) to last week, the S&P 500 is up 2% (not including dividends).  We are in a sideways market and have been for the better part of two years.  This makes sense fundamentally, as the overall global outlook for growth is now more uncertain than it was 18 months ago.  Whether or not this slowdown will be a natural lull period of the global business cycle, or will lead to a global recession remains to be seen.
      • Since Jan 2018, the Nasdaq 100 (the top 100 largest technology companies) is up 8.5% (not including dividends).  This outperformance vs. the S&P 500 is typical given the risk/reward of higher growth companies.  Something to watch going forward will be whether or not this outperformance persists or if people start selling their high growth companies in favor of more conservative options given the historic underperformance of value stocks over the last 10 years.
    • Sentiment
      • Near-term sentiment in late August had gotten close to the extreme negative levels of December 2018 (CNN’s Fear and Greed Index) where we made a short-term bottom in the stock market.  The bounce from a “fearful” state to a more neutral environment has occurred and was expected.
      • In addition to the Fear and Greed Index (which is a fairly decent contrarian indicator), the cumulative number of stocks advancing vs. the number of stocks declining is currently at an all-time high, while price remains roughly 2% below all-time highs.  This divergence has been historically bullish for stocks.
      • The AAII Sentiment Survey (a survey of “do-it-yourself” investors) data shows that as of last week, just 26.13% of investors felt positive about the stock market, while 42.21% felt negative.  For context, just before the December 2018 bottom, the bullish percentage was 20.9% and the bearish percentage was 48.87%.
      • Ideally, I would like to see negative sentiment increase further, which means the market would likely move down (about 3%-5% lower should do it).  Once everyone is convinced that the world is going to end and overreacts by deviating from their original plan (this means selling out of fear), the seeds are sown for the next advance.  At some point those “marginal buyers” get back into the stock market, and if history is any guide, it’s not at lower prices.

So, what are you supposed to do?

    1. If you’re a younger investor and focused on the long-term…all these short-term gyration mean nothing.  In fact, as a younger investor, it’s actually better if the market continues to go lower at the beginning of your financial journey.  It helps boost overall returns when dollar cost averaging over time (here is a Josh Brown interview from 18 months ago in the LA Times discussing this very situation).  The only real danger here is not continuing to save.  It boggles my mind how people (not within 5 years of retirement) get so afraid of events that have historically taken place every decade or so.
    2. If you’re in the “Retirement Redzone”…As your potential retirement date closes in, additional review becomes more and more important.  At some point, the amount of time until you retire becomes short enough to where “stay the course” starts to blend with a bit of a gamble (although it’s all a bit of gamble isn’t it?).  Most of the time, I ask clients, “Given where you want to go, do you want to continue on the same path?”   Sometimes there is no alternative.  But if your choices are between accepting market risk in the medium-term vs. switching to something more conservative, your goals need to be revisited.  Think of this as a stress test.  Because of the perceived inability to “ride out a storm”, risk tolerance and investment objectives need to be weighed carefully and often.  Communication with your advisor is paramount during this period.  If this analysis yields a possible outcome you won’t be able to stomach, you need to lower your exposure to the market.  But if you’re comfortable taking the market risk in exchange for the opportunity to continue to earn a competitive return, make sure you stick with your decision.  We can’t make this individual decision for you, and it’s not an easy one, but we can sure help you look at it from all angles.
    3. If you’re in retirement and taking income from your portfolio…focus on sectors and individual companies that have and will continue to pay solid cash flow and have a track record of doing so for a very long time (dividend aristocrats).  With the prospect of interest rates continuing to go lower, utility stocks, real estate investment trusts (REITs), and defensive sectors (healthcare and consumer staples) are at or near all-time high prices.  This means you’re probably feeling great about your income-heavy portfolio.  This too shall pass.  Make sure your primary focus is consistent cash flow, and try to disregard overall portfolio value fluctuations.  This is easier said than done, and you should be watching closely for any changes in dividend behavior across your portfolio.

The value of a financial advisor comes in the creation of a plan, effectively allocating capital based on that plan, and constantly reviewing it over time, taking into account life’s inevitable surprises.  Regardless of what we believe will happen in the stock market, you need to know what’s possible and mentally prepare for all outcomes.  Being able to stomach negative scenarios is much more important to achieving an overall plan than guessing which sector leads the charge to the next bull market.

– Adam