By Steven Rogé, MBA, CMFC®, AIF®
Director of Research and Portfolio Manager
March 9, 2017 marked the 8th anniversary of the bull market, and it received lots of publicity in the press and media. There are differing opinions as to whether the stock market is overvalued now that the Dow and S&P 500 indices are at record levels. The reason for this question is that people assume someone knows the answer, and investors should be able to trade on that information and time the market. The truth is that no one can predict what the markets will do next week, next month or next year. No one has been able to time the markets with repeatable success.
We thought the 8th anniversary of the bull market was a good time to update you on our Investment Committee’s views on the stock and bond market. While our views have largely been unchanged since our year-end update, there have been some questions from clients on whether the stock market has run too far, too fast. To put things in perspective, as of Wednesday March 8, domestic large company stocks are up 6%, and small stocks are up around 1.5% year-to-date. The stock market is driven by several factors, outlined below.
- Expectations of future earnings growth. This is linked to the outlook for the economy. The economy started to pick-up pace in the fourth quarter of last year, and this morning the ADP payrolls report showed businesses added 298,000 jobs. That is greater than the forecasted 189,000 jobs. Meanwhile, the Federal Reserve has made it clear that they plan to raise interest rates three times this year. The rise of interest rates is very important to one of the largest sectors of our economy, the financial sector. We think of financial company’s earnings as a coiled spring ready to unload as interest rates rise. Post-Great Recession, the industry had been on its way to becoming regulated like the utilities sector is today. However, after the surprise Trump administration victory, expectations quickly shifted from more regulation to deregulation. This points to higher earnings coming from financial companies and increased expectations looking out over the next three to five years.
- The lowering of corporate tax-rates. The proposed change would drop corporate tax rates to 20%. To give you an example of how that might affect corporate earnings growth, we analyzed TJX Companies Inc. (TJX), an off-prices apparel and home goods retailer. Their current tax rate is 38% and they paid $1.4 billion in taxes last year. Under the proposed tax rate, they would pay $739 million, a savings of $661 million. This would increase their earnings per share from $3.40 to $4.40 or a 30% increase. TJX isn’t an anomaly; the vast majority of small and mid-sized companies would dramatically benefit from a lower tax rate. An increase in earnings would have a direct and positive impact on stock prices for these companies.
- The deregulation of the energy industry. This will directly result in higher stock prices. Once again, the expectations running into the election was one of more regulation, but those outlooks have changed. At one point energy earnings represented around 12% of large cap stock indexes, but because of the energy recession that was reduced to 6% representation. Just getting back to its historical average should provide another catalyst to drive earnings and stock prices higher.
- The possibility of a new personal income tax bill. If signed into law this year, the bill will lower taxes for many individuals, giving them additional income to spend or save. Additional spending is good for economic growth and can add to inflations pressures.
There are many things that could derail the positive momentum drivers that we outlined above. However, we are sure not all of the positive indicators will come to fruition. However, each of the catalysts mentioned above are so meaningful to stock prices that any one of them could lead the market to record highs. Remember not to be overly concerned about the stock market being near all-time highs, because it spends about 70% of the time at all-time highs. The Dow Jones Industrials Average was at 49 back in 1914; 6,547 on March 9, 2009; and recently closed at 20,855.
The stock market will continue to do what it has always done best, confuse and frighten the maximum number of people it can, as it continues to provide returns of around 10% annually over longer periods of time. Anyone that thinks they can time the market is engaging in a fool’s game. It takes the ability to make two nearly perfect decisions: when to sell, and sit on the proceeds while losing purchasing power, and when to get back in, then repeat this process over and over again. There are plenty of academic studies that have proved the odds of doing this successfully are astronomical.
Our highly experienced and skilled team builds your portfolio around your needs, tolerance for risk, tax situation, and time horizon for use of your money. Our goal is to beat inflation by at least 2% annually to preserve and grow your purchasing power. Stocks are important in beating inflation and represent about 40% to 65% of one’s portfolio, depending upon your risk profile. The other ingredients are bonds and cash. Together, these asset classes help one another mitigate the ups and downs of stocks alone, and allow our clients to ride the kiddie roller coaster when the stock market corrects. Staying in the market through the ups and downs has always been the best advice for recovering faster and earning those desired returns.
R.W. Rogé & Company, Inc. helps clients plan, achieve and live the life they want. To learn more about how we do this, click here. To discuss your financial future with a knowledgeable Senior Wealth Advisor, contact us at 631.218.0077 or at firstname.lastname@example.org for a complimentary consultation.