A quarterly newsletter written by Brook Menees, CFP®
September 2020: Wall Street vs. Main Street
We're in the midst of a global pandemic and, according to USA Today citing statistics from the Labor Department, we have regained roughly half of the jobs lost this past Spring and early Summer due to the outbreak and shuttering of the economy. After the Labor Department reported August's new job numbers, they reported that the unemployment rate stands at 8.4%, more than double the 3.5% unemployment rate pre-Covid.
And yet, the stock market as represented by the S&P 500 Index has not only recouped all of the losses from March (Covid) Madness but has gone on to reach a record high (up 46% from the March 23rd low as I write this and up 61% back on September 2nd). Does this make any sense? Have we seen new Coronavirus cases peak yet? No, it appears that, like many countries in Europe, we may be starting a second wave (or perhaps it is the second act of the first of multiple waves, God forbid). Do we have a proven, effective vaccine produced and distributed world-wide that will get us through the herd immunity period? No…not yet. We have over a hundred vaccine candidates worldwide but none have shown “proven and safe” results with large-scale (Phase III) human trials yet…we won’t have the first of these until Pfizer Corp.’s which we expect in the back half of October or beginning of November.
So why, then, is the market trading at such high levels both nominally and in relative terms historically? For example, according to the financial website AdvisorPerspectives.com, the S&P 500 stock index is prices in the top quartile over the last 100 years when considering price/trailing 12 months earnings, price/book value, price/sales, and price/cash flow. In my opinion, there are two significant reasons for this…government financial support (by both Congress & the Federal Reserve) and optimism. First, Congress has authorized up to $3.7 Trillion on various programs targeted toward getting the American people through this crisis. Secondly, the Federal Reserve has injected in the neighborhood of $2.3Trillion supporting the banks and the bond markets to make sure they continue to function properly (like greasing the gears of a machine). Historically, this encourages risk taking as the government’s actions are acting like a backstop with global participants in the US stock market assuming that government will step in if things get ugly. If the government doesn’t, of course, this assumption could backfire. However, so far they have.
Optimism is my second reason for the stock market trading at these high levels. I believe that many market participants are optimistic that one or more of the many vaccine candidates will “save the day” by significantly lowering the risk of hospitalization and/or death. Equally optimistic are the Wall Street economists and analysts who believe that earnings of American companies will rebound to pre-Covid levels (or better) justifying these elevated stock market prices. But what if they’re wrong? What if the best vaccine candidates which are expected to be in production within the next 6-8 months have too many negative side effects? What if the best candidates won’t be in production for 1-3 calendar quarters later? What if earnings take much longer to rebound than currently expected? This would make today’s prices look much more expensive if earnings stay lower for longer.
I encourage each of my clients to determine what percentage range for higher risk assets allows for swings in returns that they find acceptable. For example, one of my clients might be comfortable with a larger variation in their expected returns (say -20% to +20% in any calendar year) while another might be more comfortable with a smaller amount of variation (say -10% to +10%). Given the historically high valuations and vast amount of economic and political uncertainty (such as what rebound in earnings will we see and who will serve as our next President), might it make more sense to reduce risk by reducing the variability of possible outcomes? For example, the person who is normally comfortable with a 40% swing in results (-20% to +20%) could reduce their risk in hopes of producing a less uncertain rate of return (ie. -10% to +10%). One can generally accomplish this by lowering one’s stock market percentage, changing the mix of stock market investments to more defensive industries, changing the mix of stock market investments to other countries or parts of the world with lower valuations, lowering one’s higher risk bond exposure and/or raising one’s more conservative bonds, or perhaps best, a combination of these changes.
Let me give you an example. Let’s say my comfort level with the range of higher risk assets (stocks & above-average risk bonds) might normally be 40 – 60% which might have historically produced annualized returns between -15% to + 15% (a 30% annual swing potential). I might decide to reduce my risk assets to the lower end of my range (ie. 40%) thereby reducing my annual swing from a typical 30% to a typical 20% swing. This is the exercise I believe EVERYONE should go through right now. What range of higher risk assets fits your acceptable range of investment outcomes? I would then respectfully suggest that moving toward the lower end of your range, given the risks I perceive to currently exist, makes some sense. If however, you are one of those people who can ignore periods of higher market volatility, larger swings in investment returns, and have enough years before you’ll likely be taking distributions, then you may be able to tolerate staying at the upper end of your acceptable range of “riskier assets”. Remember that if a person doesn’t sell while prices are depressed, then their values only went down “on paper” because to experience an actual loss, one would have to sell while prices are lower than what he/she paid to acquire them.
Ultimately, there is no single answer that is appropriate for all investors. You need to determine what variability of investment outcomes you can handle. If you would like assistance in determining your range, I would be happy to assist you. In the meantime, please continue to be diligent about staying as safe as you can from this virus. So far, I have lost my Step-Father to it, my mother was in the ICU for six days but thankfully survived it, and I have lost one client to it (so far). It is real, it can be deadly, and it doesn’t belong to a political party. If it had a brain, I imagine it would hope that you might get a little too laxed and let your guard down, making you more vulnerable to contracting it. Please don’t let your guard down. Soon, we will all have the opportunity to take a vaccine or therapeutic which will lower our chances of landing in a hospital or dying from it. Please hang in there and stay vigilant….I remain optimistic that better days lie ahead. Let’s get there together, shall we?
May God bless you, your health, and the health of your friends and family! As always, thank you for your ongoing trust and your business.
Brook Menees, CFP®
Founding Partner – Financial Advisor
2013 - 2021 Five-Star Wealth Manager Recipient *
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10540 Marty Street, Ste. 210
Overland Park, KS 66212
Securities offered through LPL Financial, member FINRA/SIPC. Investment advisory services provided through V Wealth Management, a registered investment adviser. Mr. Menees conducts business through these two legal entities using the business name “Instrumental Advisors”. Instrumental Advisors, Inc., and V Wealth Management, LLC., are separate entities from LPL Financial.
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The information provided here is for general information only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All investing involves risk including loss of principal. No strategy assures success or protects against loss. Past performance is no guarantee of future results. Any economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Bond yields are subject to change. Certain call or special redemption features may exist which would impact yield. The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad, domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indices cannot be invested into directly.