Wednesday, September 12, 2012

Staying Invested

Bloomberg Businessweek had an interesting piece yesterday noting the apparent inconsistency of a faltering corporate economy and the relentless rise in stock prices this year.

Here's an excerpt:

Really, what business does the stock market have setting multiyear highs right now? The U.S. economy grew at an anemic 1.7 percent in the second quarter. It’s creating 139,000 jobs a month on average this year; that is only a fraction of the monthly hires needed to bring the unemployment rate back to pre-crisis levels by 2015. The uncertainty of a close presidential election looms, and no one knows whether Congress and the president will reach an agreement to avert the so-called fiscal cliff—the spending cuts and tax hikes that could stall the economy next year. Europe’s financial crisis remains unresolved.

In the face of all that, Standard & Poor’s 500-stock index is up 25 percent over the past 12 months, and 14 percent in 2012. Stocks have reached levels unseen since before the fall of Lehman Brothers and Bear Stearns. “This is about the strangest market environment I’ve ever seen,” says Donald Luskin, chief investment officer at Trend Macrolytics.

Even though I remain bullish on stocks, and believe the broader market averages will be higher by the end of this year, I must confess that I am becoming a little uneasy with the rising bullish sentiment.

Strong market runs rarely start when sentiment skews positive, as it is currently. Random Glenings fave Ned Davis noted this morning that his firm's Crowd Sentiment Poll shows 68% of active managers surveyed are bullish on the prospects for the market, which is towards the higher end of historic averages.

In addition, Mr. Davis points out:

It seems to me that conventional wisdom on Wall Street is that while earnings estimates are being cut a little, still profits are coming in better than expected, and growth should continue. It is true that total corporate earnings have risen this year, but when one looks at the median stock, earnings have actually been flat this year...

...the median P/E ratio of the S&P 500 stocks was 17.6 at the end of August.  That means half of the 500 stocks had higher P/Es, and half had lower. A P/E of 17.6 is not that excessive, but it is not cheap, either.  Fair value is 1313 on the S&P 500.

So what should you do?

If history is any guide, you probably should do nothing.

More money - both real and opportunistic - has been lost by trying to time the market.  The longer run prospects for the stock market remains positive, especially compared to the alternatives, so if your overall asset allocation is comfortable you probably should just go outside and enjoy the beautiful fall weather.

Here's an excerpt from a recent Reuters interview with Vanguard founder John Bogle that offers some perspective (I added the emphasis):

Q: Any advice for people about where they should invest going forward?

A: Stock returns basically come down to dividend yield plus earnings growth. If you have a dividend yield of 2 percent, plus earnings growth of 5 percent, I think a 7 percent annual gain is a rational expectation for stocks.

I think it's unwise to get out of the stock market, or the bond market, even though the economy is uncertain. The market is often stupid, but you can't focus on that. Focus on the underlying value of dividends and earnings.

Invest as efficiently as you can, using low-cost funds that can be bought and held for a lifetime. Don't go chasing past performance, but buy broad stock index and bond index funds, with your bond percentage roughly equaling your age.

Most of all, you have to be disciplined and you have to save, even if you hate our current financial system. Because if you don't save, then you're guaranteed to end up with nothing.