I’m sure you agree that the current stock market has been on quite a winning streak now. The stock market has gained nearly 25% under President Trump.
The Dow Jones Average just crossed the 26K milestone. And while that may seem like good news, it is smart to evaluate the risks to the current stock market.
Here are some contrarian views on the stock market and major indexes.
In my view, the risk to the stock market is not a crash, but a more nuanced scenario for stock investors.
For most stock investors, the risks to the stock market are rarely discussed. Here is my view of the risk to investors from the current stock market in the coming years.
Current stock market: So here we are ~ Dow 26K.
- Let’s review how we got here:
- The financial experts predicted a stock market crash if Brexit passed.
- It did and investors shrugged it off.
- Then the stock market strategists warned us that if Donald Trump was elected, the stock market would crash.
- The market has since rallied 12-15% to new highs in every index. Even cyber currencies like bitcoin, cryptocurrencies, and etherium are at new highs. And here we are at very rich valuations compared to historical stock prices.
Most mutual fund managers were underinvested heading into the election.
Since Trump’s improbable win, professional investors have been playing catch up– trying to get invested in a stock market that has not fallen by more than 1% on any day for a month- something that hasn’t happened in 54 years. This applies to the S and P 500 as well as the Dow Jones Average, the major stock market indexes. Stock market Volatility has been crushed.
Retail is Bullish: Individual Investors
Individual Investors are pouring money into this market. Discount firms TD Ameritrade (AMTD) and E-Trade (ETFC) are seeing a huge appetite for stocks by retail investors.
Inflows to mutual funds and ETF’s hit $32B through last Wednesday, the largest inflows since 2002.
ETF’s focused on Bitcoin shares have received $258M in a matter of days. All retail brokerages are seeing new account openings fueled by millennials and those who fear missing out.
For seasoned investors, this is reminiscent of boom days gone by. We don’t know how these new investors will react when volatility returns to the market. But, retail excitement is almost always a sign that the easy money has been made. And in my opinion, passive investing may exacerbate a downturn.
Davos Is Bullish:
“There are 2,000 people [here in Davos], and I don’t think I’ve met one person who’s been negative,” -Billionaire Jeff Greene (NASDAQ:CNBC)
Stock Valuations are very stretched.
Depending on the figure, we are at nearly 26X earnings on the S&P 500. Levels last seen in 1929, 1999, and 2008.
This means the current stock market via the S&P 500 index is expensive. However, due to the intervention by the Federal Reserve in the bond market, the stock market is viewed as the only alternative for most investors. This is a very unnatural situation. As a value stock investor, I can tell you there are hardly any undervalued stocks on the New York Stock Exchange. Very few stocks are undervalued. Investors may ask, “Is the stock market going to crash?”
The risk is not a stock market crash. The real risk is that 7-10 years from now, we are still at or below 2400 on the S&P 500 or 21,000 on the Dow Jones Average.
Why? The Federal Reserve, the Central Bank which essentially controls interest rates, has used emergency level interest rates going on 7 years. This was used to stimulate the economy due to the financial crisis. The federal reserve has a $4B balance sheet.
Interest rates have been at historic lows. This has boosted stocks and real estate artificially.
Pulling future gains to the present. If we have taken future returns, then future returns should be lower going forward.
The fed has been artificially supporting the market. We don’t know what will happen when they unwind their balance sheet and rates return to normal levels.
Artificial support.
My stock market analogy:
When I ran this morning, I cheated a little bit. After I ran, I was walking on the treadmill, but was holding on to the side rails. It’s cheating. My arms were supporting my body. That’s what the fed actions and the stock buybacks have created. It’s artificial support.
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Are companies doing well? Yes and No. They’re shrinking their shares outstanding by buying back stock. Where does the money come from? Mostly from issuing bonds aided by low interest rates.
Stock Buybacks used to be done exclusively by companies that felt their shares were undervalued. Today, almost every major buyback is being done at all time highs.
Think about that. “Were buying back our stock because it’s undervalued … at All Time Highs!”
I’m not impressed.
There is a big difference between running 5 miles and walking 5 miles holding the side rails of a treadmill. This market has been sustained for far too long with artificial support. I’m cautious and skeptical.
My intention is not to scare investors. However, smart investors need to consider that the risks to the stock market do not just include some stock market crash like we experienced in 1987 or 2008.
The more significant fear for investors is something more devastating: a return to normal returns and potentially, much lower rates of return for stock market investors. The Federal Reserve has been helping investors for nearly a decade. When they remove the artificial stimulus, rates of return may fall and create a disappointing climate for stock market investors for many years.