A Late Stage Market Melt-UP

Without doubt the investment year is off to a great start. The stock market in the US is up 8%. January’s return is the best one since 1987. The way things are going we could see a repeat of 2013, one of the best diversified return years ever. What is going right and what could go wrong?

Why January is strong

January’s stock and bond market returns are strong due to fundamentals. Stock valuations are fairly cheap, earnings are increasing at 9%, dividends and buybacks are rising, taxes are lower and merger/acquisition activity is lively. Bonds are up because interest rates are a little too high. There is low inflation despite a tight labor market. The global economy is still deflating prices worldwide despite trade wars. After ten years there is no recession in sight and the Fed now seems set on slowing any rate rises or balance sheet shrinkage.

What could go wrong

The number of things that could go wrong for the investment world is shrinking. They are now mostly confined to horrible things happening to world leaders, like death or major illness. Of course, a major war, terror spree or other geopolitical crisis could disrupt markets. Any of these are possible, but none appear probable. In fact, the constant jawboning, negotiations, cancellations and re-establishments of trade and political order may lend some stability to the investment world. If we are arguing, we increase our chances of a solution or cease-fire.

Where things get interesting

Imagine a first half diversified portfolio return of 10%. We are only 3 percentage points from that right now. When a diversified portfolio hits that level by mid-year there is tremendous pressure to catch up for those who are sitting on the sidelines. I can easily see a high teens return this year: not as good as 2013 but one of the best years in this decade. Such returns are possible even with a Brexit and continued crackdowns on the big social media companies. A very good return year would be helped by just slightly higher oil prices.

I include emerging markets in the melt up category because they are cheap on an absolute and historical perspective.

Investing for 2020 and 2021

I have urged investors to take a three-year approach to investing in this late stage of cyclical economic growth. For those who can tolerate ups and downs a three-year timeline of investing can get them through the quarterly changes in the economy. Three years is important because a late stage advance is often very large, followed by a sudden decline as a recession hits.

Of course, there are some investors for whom a three-year approach is not useful. If you need the predictability of large and regular amounts of money, please take a more defensive stance. For example, 30% in Tbills. This hybrid approach reduces expected total returns, but also increases certainty. In this example, your overall return would be 10% if the diversified portfolio return is 15%. When you need cash flow, it makes sense to trade a higher return for steady capital preservation.

Take a look at our sample portfolio

If you would like to see a typical investment approach, send us an email. We start with four main portfolio approaches for Osbon clients. We work with a full range of clients from those who want maximum long term growth “forever” to retirees who only want income. What’s your situation and what does the “ideal” look like to you?