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Do I Hear 27,000?

by Wayne Schmidt, CFA

Posted on February 1, 2018

Have you ever tried to buy something at a live auction only to watch your item of interest fly right through your price target and sell to another bidder? The January stock market had the feel of a live auction as the Dow Jones Industrial Average eclipsed the 25,000 level for the first time in early January and passed the 26,000 mark just seven trading days later. Fortunately, the stock market is it is open for business most days and can handle multiple buyers.

The echoes from the market pundits in early 2017 still rings loudly in my ears. It was one short year ago with the Dow at 20,000 and the market experts were telling anyone who would listen to sell stocks and wait for a 10% correction. Sorry folks, but market timing is not a long-term solution to creating wealth.

Morningstar's 2017 top mutual fund equity manager from Fidelity credits their multiyear successes to patience, outstanding research, and commitment. Their portfolio turnover is 25%, or stated another way, they hold a stock for four years on average. They use price declines in a stock as an opportunity to build a position, (i.e., buy more when prices are low). Warren Buffet has been doing this for years. He is doing okay too.

The problem for us mortals is we allow emotions to cloud otherwise clear thinking. If we could check our political views at the door, stop looking at account values on a regular basis, stay committed to our financial plan, remain patient with a long-term focus and tone down the media market hype, we would all be on to something.

January 2018 financial markets were an extension of 2017. No one told the market it was a new year. Rather, the story from last year replayed itself. Stocks outperformed bonds, emerging market equities had the highest returns but all stock markets earned medals for an outstanding month, growth led value and large capitalization stocks beat small capitalization stocks. This bull market is real and it is being driven by the same fundamentals that drove previous bull markets. Let's review:

  • Macro-economic conditions are positive; highlighted by a confident consumer, escalating home prices, higher household aggregate net worth, lower taxes for corporations and individuals, and decreased government regulations
  • Corporate earnings continue to be strong, and we expect to see another year of double digit earnings growth.
  • Valuations continue to expand as interest rates remain in check.
  • Corporate news is generally positive

Bonds were once owned for their income producing qualities and the potential for capital gains as interest rates fell. Interest rates have basically been on the decline since 1981; the best years for the bond market are likely in the rear view mirror. This does not mean bonds should be ignored, instead their role in a portfolio will be redefined from a source of meaningful income to a source of price stability. The days of bonds generating 5% income and 2% price appreciation are being replaced with 2-3% income and zero to 1% depreciation. Dial back your return expectations in this new world of low interest rates moving gradually higher and tight credit spreads trying to hold their line.

It has been over 400 days since the U.S. stock market experienced a 5% correction. At some point, there will be a correction greater than 5%. Count on it. The late month rise in 10-year yields to north of 2.7% may just be the catalyst for a correction. When it does finally happen view this as normal, not a reason to sell everything.

Rebalancing your portfolio back to your targeted asset allocation is always a great idea, especially in times of extreme market strength or weakness. Nine years into this bull market provides a unique opportunity to rebalance your portfolio from a position of strength. Remember, this is not an all-in or all-out decision, but a rebalance of your risk allocation at the margin and continue moving forward.