Earlier in the week, I wrote about the importance of identifying one’s time frame when trying to win in Ms. Market’s game. As I opined, trying to use a long-term approach to succeed from a short-term perspective can cause a great deal of both emotional and financial pain. As such, it is critical to know which of the three major time frames you are focusing on: Short-, Intermediate-, or Long-term. And it is for this reason that every couple of weeks, we attempt to succinctly summarize the outlook for all three.
So let’s review. From a short-term perspective, I’ve written that the trend is clearly a friend to the bulls right now. However, stocks are indeed overbought, sentiment has become too upbeat/complacent, and the seasonal cycle becomes a headwind from next week into early October. As such, I’ve suggested that investors plan accordingly and be prepared to buy the dip (or to put money to work in their portfolios for the long-term).
Looking out over the next 3-6 months, we believe the keys include the outlook for both earnings and the economy as well as the state of Fed policy. So, given that (a) the recent economic data (including this week’s LEI) has been decent and supports the prospects for further growth, (b) earnings are expected to perk up during the next reporting season (remember, oil has been a major reason for the earnings recession and oil is now moving higher), and (c) that global central banks continue to implement their QE programs, it is hard to be overly negative on the market.
From a longer-term point of view, we contend that stocks embarked on a new cyclical bull market on February 12, 2016. And as we’ve discussed, this new cyclical bull is occurring within the context of the secular bull trend that began on March 9, 2009. If we let history be our guide, this means that the cyclical bull should be stronger and longer than average and any cyclical bears that occur along the way (such as those we saw in 2011 and from August 2015 through February 11, 2016) should be shorter and shallower than average.
However, the bears contend that valuations are a big problem (the goal from our furry friends here is to conjure up memories/fears of 2000) and that we should be worried about the election.
On the first score, there is really no denying the fact that the absolute valuation metrics such as Price-to-Earnings/Dividends/Cash Flow/Book Value are at very high levels.
Yet it is important to note that when interest rates and the economic backdrop are taken into account, valuations are not at extreme levels. In fact, when considering the “relative valuation” of stocks and interest rates, the current levels are actually quite bullish.
Then when you consider the fact that the economy is growing and earnings are improving, even the absolute valuation picture doesn’t look so bad. And unless we see a 1999-style surge in prices or a very large spike in interest rates, we are of the opinion that valuations are not a reason to avoid stocks – even at these lofty levels.
For me, the bottom line here is the issue of valuation lies in the eyes of the beholder. So, you can either take defensive action now on the assumption that this won’t end well -or- decide to ride the bull train until there are signs that valuations matter to the market (such as when the economy weakens, inflation perks up, or the Fed gets aggressive).
As for the much ballyhooed election worries, I believe it is important to keep in mind that Wall Street really doesn’t care which side wins the White House in November. No, from a stock market perspective, presidential elections are really about expectations and/or uncertainty. And with Clinton leading in the polls of many key battle ground states, there doesn’t appear to be much fear or uncertainty in the market at this time. However, if the race tightens or if candidates start to talk about implementing pans that would be considered anti-growth, this situation could change in a hurry.
So for investors, I will suggest that one should pay more attention to the outlook for earnings and economic growth than the election – as far as investing in stocks and bonds are concerned, that is!
The literal bottom line is that while things may get sloppy in the near-term, there doesn’t seem to be a reason to be defensive from a longer-term perspective. However, I will be sure to alert you if things appear to be changing.
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