The Market’s Next Phase

Almost a year ago to the day, I wrote an article that discussed a well-known quote from a famous investor, Sir John Templeton.  He said that ‘Bull markets are born on pessimism, grown on skepticism, mature on optimism and die in euphoria.’

Clearly, the bull market that we’ve enjoyed for the last nine years was born in the pessimism of the 2008 global financial crisis.  The rally grew on optimism and last year, I wrote that we had transitioned from growing on skepticism to maturing on optimism.

The absurdly strong performance of the stock market this year, up 7.55 percent so far, makes me wonder whether we’re moving to the fourth and final stage, from optimism to euphoria.

I read two articles over the weekend that caught my attention.  The first was from Friday’s Wall Street Journal.  The headline reads: Lured by Market Records and Hot Bets, Individual Investors Finally Dive In.

The subhead reads, ‘Discount brokerages report surging trading volume, particularly among younger clients, in part due to interest in crypto-currencies and cannabis.  Here’s a link to the article.

The article describes how retail investors have poured money into stocks, stock mutual funds and ETFs through discount brokers like Schwab, TD Ameritrade and E-Trade.

The article concludes with ‘the question for many analysts and investors now becomes whether surging retail trading and interest in nascent, highly speculative markets are signs that the market is overvalued.’

Personally, I’m skeptical of stories that describe retail asset flows because the tools they use to measure flows aren’t very good.  Further, institutional investors are always looking down their noses at retail investors, but are usually guilty of the same bad behavior (they just have better stories for themselves).

Then I read an article in the Washington Post on Saturday with the title, ‘Hold tight or splurge?  Booming retirement accounts are making that a tough question.’  Here’s a link to the article.

This article featured antidotes from advisors talking to their clients, who want to spend their newly found market gains.  One client wanted to take $20,000 out of her 401k account to go on vacation.  Since she’s not yet 59 1/2, the withdrawal would mean a 10 percent penalty on top of the ordinary income.

This article focused more on the wealth effect.  They quote a professor from Northwestern’s Kellogg Business School who says, that people think that ‘if I’m richer for good, I’m going to spend more.’

Although I feel bullish about 2018 as well (is that a sign?), I think we all recognize that the windfall that we received last year could disappear or at least diminish rather quickly.

So far, our clients wouldn’t be worthy of a quote in either story.  While a lot of people ask about marijuana stocks and bitcoin, very few are trading either one.  More importantly, no one is acting irresponsibly by taking out more than what they had planned.  Okay, maybe a touch more, but not substantially more.

In fact, I would say that most are treating the rally is making some of our clients nervous.  A handful have asked if it’s time to get out.  The Washington Post article does reference this view as well.

Although I think it’s good to be cautious and skeptical, I don’t think that people should bail out of the market.  I wrote almost four years ago that markets were overvalued (click here for the article) and wonder aloud what should be done about it.

Selling at that time would have been a disaster because the S&P 500 is up 71.3 percent since then.  Thank goodness that I didn’t counsel anyone to sell, and urged people to hang in there.  Maybe now is a better time, but it’s totally impossible to say.

I do think we may be entering a period of market euphoria, but we won’t know for sure until after the fact.  Even if we are entering into a market euphoria it could go on for a long time.  At what point did the late 1990’s rally turn into a bubble?

Former Fed Chair Alan Greenspan gave his famous ‘irrational exuberance’ speech about stock valuations in December, 1996.  He may have been right, but the S&P 500 rallied for more than three years and more than doubled in the meantime.

In my humble opinion, the conclusion to my 2014 article is good advice for all four phases of the market, regardless of where we are now:

[Analyst Mark] Hulbert ultimately concludes by saying that ‘timing the market is notoriously difficult, so you might choose to stick with your stock positions through it thick and thin.’

That’s pretty much our approach, the key is making sure that you’ve got the financial and emotional wherewithal to stick to your plan when the bad times come, whether that’s next week or in five years. If you’re unsure, now is the time to work with us to figure out the right path forward.