Steering Through Uncertainty
Media coverage has been focused entirely on our new president. Like it or not, we’re probably in for more of the same “Trump 24-7.” All the while, the stock market has been notching all-time highs.
The post-election returns are impressive, but many find the current situation tenuous. Here is our perspective on questions we are receiving:
Q: I’m concerned about the political situation – even with all the enthusiasm about tax reform, deregulation and spending, isn’t it likely that we will see a sell-off from the current highs?
A: It is surprising that markets appear to be calm in the face of so much uncertainty. We are hoping for the best (which might be described as a fully functioning government), but have no idea how this will turn out. Regardless of the outcome, it appears that the process will be highly contentious. Investor confidence in the agenda and its prospects for enactment may wax and wane. Meanwhile, a much broader set of risks (in the economies and banking systems of China and Europe, for example) that have been relegated to the background since the election are still with us.
In the end, markets have a way of defying predictions. The inevitable decline that will generate lots of hand-wringing could be around the corner or years away. Some facts are helpful for context. Based on data going back to 1950, there is a 30% chance at any point in time that the S&P will trade 10% lower over the ensuing twelve months. (Source: Bloomberg, Morgan Stanley). However, history also tells us that the odds that the market gains 10% or more within the same time frame are far greater than 30% (about 45%).
Q: Aren’t stocks too expensive when they’re at their highs?
A: Above-average valuations may be justified by improving outlooks for the economy and corporate earnings. It’s also worth pointing out that it’s only the US markets that have been making new highs. In Europe, operating profits have returned to 2007 levels, yet indexes remain about 25% below their peaks registered in March 2007.
As portfolio managers, we do our best to remain focused on what we can control – what we own, and how much we own. Importantly, we are managing portfolios of individual stocks. We don’t view any of them as too expensive, and many are nowhere near their highs. Our analysis identifies one or more catalysts that should propel their prices higher over time. While it helps to have the support of a buoyant market, the success of each holding will be driven by many factors besides the level or direction of the stock market.
Q: As an investor, how do I deal with the unknown?
A: It is important to focus on how your financial plan and the associated asset allocation are designed to help you weather volatile markets. If you are in retirement and spending from your investments, check to see if your cash and near-term bond holdings would cover a few years of anticipated spending to see you through a market downturn. On average, it has taken from two to three years for equity markets to return to previous highs after a major selloff.
Q: I appreciate all of this, but I’m still not comfortable. What can be done?
A: You have to bring the discussion around to your financial plan to evaluate if you are invested for long-term success. (If you don’t have a plan, you should!) If there is a mismatch between your needs and your investments, changes should be considered irrespective of where markets are headed in the short-term.
If your plan indicates that you have the ability to maintain your current risk level, but you’re still losing sleep, investigate the planning implications of an adjustment to your asset allocation. A small trim to your stock holdings may serve to settle your mind and keep the plan on track. Do not view investing as an all-in or all-out decision – think in terms of increments.