The Market Is Going to Drop

What I’m encouraged about:

The U.S. consumer is still strong.  There are nearly two jobs available

What I’m keeping an eye on

Reduce exemption on estate tax ($5.5M).  Dropped attack on step-up in cost basis in capital gains.  Capital Gains rates may still be going up.  SALT deductions increase proposed.  All of which are summarized as “legislative risk” and fiscal policy.

Despite labor market challenges, producer confidence is currently high with smaller businesses, however, consumers are less optimistic about the future as measured by the consumer confidence index:

• Debt ceiling limit. Measures taken by U.S. Treasury will run out by mid-October.  Both parties continue to dig their heels in and are holding captive other provisions such as the continuing resolution and disaster relief. 
• Markets fundamentally do not like uncertainty and typically reacts with volatility.
• The market is a forecasting tool, constantly weaving above and below “truth data” as realized econometrics are revealed. Reversion to the mean. 
• Inflation

Considering current market conditions, it is little wonder why financial headlines and conversations are saturated with concerns of “sustainable market prices.” We are naturally tempted to “pull in our horns” in the face of uncertainty.  This response points to the psychological phenomena at play referred to as “anchoring” or “heuristics”.  We have short memories and are often influenced by the most recent or acutely significant events that shape our perspectives.  Additionally, the fear of loss has been shown to have twice the negative effect on our psyche than the positive reward of gain³.  We cling to our perceptions and fears as these emotions tend to have greater sway over our behavior without a conscious effort to engage our frontal lobes with facts, logic, and reason. 

Admittedly I don’t love this market.  I don’t like investing clients’ new cash into it.  I don’t like the “multiples” or the valuations in U.S. equities.  I find myself holding my nose and making purchases.  I fully expect a correction to come, however, I’m forced to remind myself of the financial “gospel” I preach from the investing pulpit:

1.You’re in it for the long-run (subjectively defined)

2.You can’t time the market

3. The “right” portfolio allocation should be coupled with a sense of comfort in both feast and famine.

4. The market is up far more times than it down…ie there are more times of “feasting” than “famine” – see #3.

5. Missing the 12 most productive days of market gains in a given year significantly reduces or eliminates the participation in the investment’s annual See #2. 

6. Diversification works to eliminate the risks that can be eliminated – namely, unsystematic risk unique to concentrating investments in specific companies or sectors.

While I’m not enthused about market conditions and future expectations of inflation, I’m encouraged by the following:

1. Unemployment rates are decreasing⁴

2. GDP is increasing

3. Manufacturing and Non-Manufacturing gauges are signaling expansion⁵

4. Corporate earnings have returned to pre-COVID levels

These are real, measurable facts that support continued economic expansion.  Only theories can attempt to justify the market’s response which is seemingly un-ending gains.  In short, there are few alternatives.  Bond yields remain low on a relative basis, and I’m not sure that other asset classes (such as commercial real estate) are appealing. 

The market is at or near record highs and seems to keep marching upwards. Economic stimulus has logically provided the market with enthusiasm for brighter days ahead.  Why am I not touting portfolio performance?  In short, my objective and duty to clients is to keep your eye on the prize.  Short-term gains and losses of any amount are mere data points.  We should expect bouts of volatility, and frankly, we’re due for a correction.  Stay focused, and if you have any questions about your investments or financial plan, then we should connect and discuss it. 

References:

1. American Funds,Capital Group: https://www.capitalgroup.com/advisor/tools/guide-to-market-volatility/articles/what-past-market-declines-teach-us.html
2. Charles Schwab Online: https://intelligent.schwab.com/article/stock-market-corrections-not-uncommon
3. com: https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/loss-aversion/
4. CNBC (Citing US Labor Department): https://www.cnbc.com/2021/04/02/us-jobs-report-march-2021.html#:~:text=Nonfarm%20payrolls%20rose%20by%20916%2C000,the%20fastest%20since%20August%202020.
5. Institute For Supply Management: https://www.ismworld.org/supply-management-news-and-reports/reports/ism-report-on-business/services/february/