Tom Bradley is president of Steadyhand Investment Funds Inc.
The debate rages on. Is the market going higher, or is it highly overvalued? The reasoning is compelling on both sides.
The bulls point to the fact that the global economy is solid. Europe is bouncing back and the U.S. continues to grow. As a result, corporate profits, the ultimate driver of stock prices, will be good.
Their view is that interest rates won’t go up significantly because inflation is low, and consumers and governments can’t afford higher rates. And importantly, the bulls see nothing on the horizon that will trigger a sell-off.
On the other side are the value investors who feel just as strongly that a down market is looming. They acknowledge the economic growth, but point out that it will be chronically slow due to demographics (the Western world is getting old), debt (too much and too speculative) and a lack of productivity. And the political uncertainty in Washington and Europe won’t help.
As for valuations, the bears point out that stocks are expensive and bonds even more so. Price-to-earnings multiples are at historic highs (if you take out the tech bubble) and the “can’t afford it” argument for low interest rates doesn’t hold water. Mr. Market is insensitive, self-centred and often grouchy. He doesn’t care about what we can or can’t afford.
The bears’ view can be summarized in one sentence. Paying high multiples for (cyclically) high profits is a bad combination.
Like any political debate, both sides may claim victory in the end. It’s a matter of time frame. Think about a scenario in which markets trend higher for another 12 to 18 months and then experience a significant correction. Both sides could claim bragging rights.
In face of these opposing views, how should you set your course? Is there something you need to do with your portfolio? Here’s my guide to getting the most out of the many and varied market predictions.
Start by putting it all in perspective. Neither side knows where the market is going. There are thousands of factors that impact the market’s path. Some are highly visible (i.e. interest rates, currencies, demographics and government policy), but most are not. Add in the inconsistent relationships between the multitude of factors and events, and you’ve got an impossible task. Don’t get too caught up with who is right, but rather focus on the thought process. Look for facts and insights that will help inform your long-term strategy. The fact that stock and bond valuations are well above their long-term averages won’t help you identify a turn in the market, but it does indicate that returns are going to be modest over the next five years.
Be mindful of simple solutions. For instance, as rates move up, valuations will reset and stocks will decline. Unfortunately, it’s not that simple. Any number of combinations are possible.
Don’t spend too much time searching for triggers, catalysts and tipping points. Like sports commentators who list their Keys to the Game, we rarely get them right. We won’t know what the catalyst is until after the fact, and even then, it may not be clear what turned the market.
And, by all means, don’t bet the farm on either view. You shouldn’t put all your assets in interest-rate sensitive securities such as bonds, real estate investment trusts and high-dividend stocks, or in economically sensitive sectors like energy, resources and banks, or under your mattress.
I don’t pretend to know where markets are going in the next few months or quarters. Instead, I’m mining the market predictions for information that will help me assess the attractiveness of different types of securities.
In the fund I manage, the Steadyhand Founders Fund, I’ve admittedly taken more from the bears’ view in formulating my strategy. I still own bonds, but fewer than usual. As a result, cash is a big part of the fixed income allocation.
As for stocks, my weighting has come down because of those lofty price-to-earnings multiples. It seems to me we’re in extreme times with regard to valuations and investor complacency, but I never want our clients to be anything but fully diversified.
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