Where to now?
Things seem to be getting back to normal. The fight for the Covid relief bill is done. While it’s merits will be debated for months to come, it’s the new reality, deal with it. Bond yields continue to perplex the market and impact stocks (as well they should) while investors try to figure out how to play it. Inflation may be starting to rear it’s head and unlike many others, I think it’s ok to have a little inflationary pressure.
The headlines for the next few weeks will be about the reopening of the economy and the positive impact it will have on the Nation. For example; Empire State manufacturing numbers came in higher than expected and while I don’t believe that these numbers have much relevance to the economy as a whole, they are a very positive sign in a region that was devastated by the pandemic, so it’s importance is elevated, at least for now.
Things are trending for the most part in a positive direction. More people are flying, hotel bookings are up, theaters will be reopening around the country as the Spring grows into summer, Unemployment continues to fall and housing numbers have remained fairly strong. The wave of consumer spending will continue to grow and that alone can lift many boats.
With all that being said, why am I so cautious on the market?
As you have gathered now by reading my column for the last few weeks, I look at things in the simplest terms. I do not complicate my thinking by overthinking and have always tried to keep to my philosophy. Common sense and keeping things simple.
Looking at equity markets over the last year without knowing the underlying story of what was happening in the World, you would think that we had this massive correction in early March and then the market rebounded and continued it’s upward trajectory. Money flowing into equities was substantial and unabated and did not reflect the actual economic conditions of the day. That disconnect will be the subject of dozens of books trying to explain it and in all those books, I am sure there will be some variation of the “Market is looking 6 to 9 months ahead” theory. Originally, in Mid July, I felt that was the case and as last year struggled along I felt that that theory may not be accurate anymore and we were moving into a phase of market exuberance we have seen before. “Irrational exuberance”? Maybe.
Looking at things from a simplistic approach, as I often do, you could say that the pricing of securities has gotten way ahead of itself as PE’s for numerous stocks were well above their historic highs and to me, thats a breaking point. Anytime a stock trades at such multiples, they tend to self correct or the market does the correcting for them. Stocks, over the long haul, will trade at some PE multiple that is consistent and the variations tend to be small but we are now in a place were multiples do not justify the pricing and it won’t take much for that correction to take place. Bringing stocks back in-line to their present earnings and future earnings forecasts.
We saw some of this several weeks ago as Bond Yields started ticking up and the Tech sector softened enough that the NASDAQ was off around 10% from its all time high. To me, that isn’t a true correction only because the price points were the calculations are made are not a solid indication of a market peak. To me, taking the average of ten trading days before the market top and using that number is a more accurate reflection as far as corrective actions go. Using that as a basis, a correction in the NASDAQ would be around the 12,375 level and we did not get there. Obviously, my methodology is simplistic, but it does take those upward spikes that constitute new highs and soften them a little. Ten trading days is just an arbitrary number but it does allow for a mini bull cycle. The same can be said for a downward trending market as well.
Even though this was not a correction by my standards it did give us an opportunity to look at the pricing of a sector and the underlying risks of investing in overvalued stocks.
I do expect a real correction at some point and as I have said countless times, it will be healthy for the market to revalue its components and let investors reassess where they want to be for the near term.
Don’t get me wrong here. I am not bearish on the economy at all. I see so many positives that sometimes I think I might be trying to talk myself out of investing when I should be talking myself into investing more but my common sense thinking just keeps bringing me back to over valued and over hyped markets and what eventually happens to all of them.