A Little Bit Can Go a Long Way

every little bit helps

 

So far 2018 has been a “much ado about nothing” type of year. And I personally find this to be wonderful!

Why would I want markets to move up and down to essentially end unchanged? Because I believe it is the healthiest thing for the longer-term.

The domestic economy is gradually improving, and the global economy is finally on solid ground as well. Against this backdrop, it might seem logical that markets would be moving strongly upward.  But it needs to be remembered that markets do their best to judge the future, neither the current nor the past. In other words, last year‘s overly hot market was pricing-in this current economic reality. You could say last year’s prices were pre-pricing this year’s economic strength.

So where does that leave us now? If the market is moving sideways, does that mean it is forecasting a less than stellar future? Or does it mean it is simply digesting the overpricing binge of last year?

Judging all the economic data and corporate earnings announcements, I believe the future is in good shape. I believe this pause in the markets is a very healthy one and will serve as a rest before a run and not any sort of calm before a storm.

There is actually a growing camp of analysts and economists that are calling for a strong and dangerous upward surge in the markets which would lead to a very ugly end.  In their analysis, the markets would rocket higher up to levels that are unsafe and would ultimately fall apart.  It’s a Melt Up theory that leads to a Melt Down, based largely on the notion that things went way too high too quickly.  If indeed we were to start ramping higher in the markets, I could see their point in this analysis.

This is exactly why I am so happy to see the first part of 2018 be subdued. The longer the markets churn sideways and digest last year‘s big rally, the healthier they become.  What might have been perceived as excessive valuations gradually fade away as corporate earnings catch up to prices their stocks have already achieved.  Not to mention that speculative excesses in investor behavior also wane. And this is very important.  What we have seen from past peaks is that as investors and institutions alike rid themselves of common sense and discipline, they are essentially speeding up their car down what seems to be a safe straightaway just before the hairpin curve they cannot handle.  That is not the case today as there is so little evidence of excessive optimism.

In life we rarely get exactly what we want, so we should be happy with something that at least comes close. To me, that would be a repeat of the year 2011 in the financial markets. If you can think back to that era, headlines were dominated by the “PIIGS” of Europe and how they would rip apart the Eurozone. Headlines were also dominated by the prevailing notion that the recovery from the bottom in 2009 had everything to do with quantitative easing and Fed manipulation rather than any genuine healing in the economy. Opportunistic marketers were taking full advantage and putting forth their “End of America“ theses over and over again until they eventually were so badly embarrassed they threw in the towel.  And all the while, the stock market tossed and turned and ended the year right where it started.

And what might seem at face value to have been a “throw away” year was tremendously productive for investors.  The market had a very refreshing pause that helped usher-in the next multi-year upward leg of the current bull market.  Speculative excesses were burned off as the economy improved underneath the higher valuations, making them more reasonable.  And, for lack of a better phrase, people simply calmed down a bit.  After such big runs, markets – and market participants – needed to catch their breath.

We are in a similar situation now, so a similar outcome would be fantastic.  The only people who wouldn’t benefit are those that are myopically interested in the value of their portfolio in the coming weeks and months.  But for those of us interested in the value of a portfolio over the coming quarters and years, a healthy pause is to be celebrated.

This reminds me of a table I’ve referred to in the past. I think it’s worth showing again. It illustrates how the market achieves its long term average return in anything but an average, or a linear, way.  I showed this in a Worth Considering piece back in 2015 and market returns since then have only emphasized this point.

 

According to research from friends at Suncoast Equity Management, the S&P 500

has had an average return of 6.5% throughout their 17 year existence.

Updated: the S&P has returned an average of 7.1% over their 20 1/4 year history as

Of March 31, 2018

To illustrate an important investment point, they put forth the following:

“But how many years since our inception came within the average? 

You might venture a guess and say half. 

And how close would you be to the correct answer? 

Not at all close. 

You would be surprised to learn that during only one year

did the S&P fall in the +5% to +10% range.”

Take a look at their supporting table below.  To us, this proves that average returns

are anything but ‘average’.

                                                                                              Calendar Years
                             Annual Performance Range                                S&P 500
                                            -40 to -30%                                 2008
                                            -20 to -30%                                 2002
                                            -10 to -20%                                 2001
                                              0 to -10%                                 2000
                                               0 to +5%                       2005, 2011, 2015
                                            +5 to + 10%                                 2007
                                            +10 to +15%                   2004, 2006, 2014, 2016
                                            +15 to +20%                             2010, 2012
                                            +20 to +25%                             1999, 2017
                                            +25 to +30%                        1998, 2003, 2009

                                            +30 to +35%

                                  2013

Through this table I’m hoping to show that if 2018 is a year that finally gives 2007 company in its range, or even if it were to be a row or two beneath it, this is likely to be a very constructive year.  A better foundation would be set for the years ahead; certainly better than if the market were to accelerate into higher ranges before the next wave of economic growth would warrant.

As we look out toward the second half of 2018, there are some important events to move through.  There are plenty of economic and political items on the plate.

We have the talk of trade tariffs to deal with. We have a Federal Reserve that is still trying to normalize interest-rates. We have their counterparts in Europe trying to successfully sunset their own quantitative easing programs.  We have whatever might be happening with North Korea.  And of course, we have midterm elections. Should this give investors reasons to throw money under the mattress or otherwise be overly conservative – or even frightened? I think not. After all, it’s always something. There’s always something, or many somethings, to focus on if you want to be fearful. But I don’t perceive any of these issues to be as dramatic as the media characterizes them. None of them alone, or even collectively, look positioned to

undermine the gradual growth of the global economy.

With all of this in proper perspective, I will continue to quietly cheer for more sideways movement in the markets. This is because I am far more convinced it would be a pause within an upward trend and not a peak looking to turn downward.

The takeaway:  Don’t be discouraged by the fact that the markets haven’t done much this year. Quite the opposite, take heart in it.  As the global economic backdrop improves, recognize that immediate gratification we might not get this year just means more is left in store for the future. In other words, this pause will lengthen the upward trend of markets. This outcome would be far better than a reckless rally that would vastly increase the odds of the end of the bull market being closer at hand.

 


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