A steady current of surprise and unease has been running through the popular financial press and blogosphere during the long current bull run for US stocks. Many pundits seem confused and worried, like ducks in the desert, that something is seriously wrong. The S&P 500 is now up 100% since the bad old days two years ago. And the benchmark index is up 100 points this year alone, despite many gloomy forecasts, such as this one from January 2011 that called for major reversals that have not materialized. Why are stocks doing so well?
There’s no magic to the US equity market’s sustained rally this year, and for two years running. Many factors move the market day to day, but in the long run it’s the financial performance of listed companies that determine what stocks do. The fundamentals – earnings, growth, margins – have been consistently positive in recent quarters. Clearly, many experts did not see this coming. And many investors, trusting what they saw on TV or read on the internet, have missed out on the big rise after bailing out during the big fall.
That the market could regain most or all that it lost during the financial crisis is not a complete surprise. It’s the timing and speed of the move that has left many on the outside looking in.
Why the profits?
Frankly, the consistent quality of fundamentals has been a surprise to me, too. But here are a few elements that help to explain what we’re seeing: free money, low taxes and cheap dollars.
Free, or almost free, money makes profitability a lot easier. Last August, IBM borrowed $1 billion for 3 years at 1 percent! Johnson & Johnson raised $550 million for ten years via bonds paying less than 3 percent. With that kind of low cost leverage, it’s hard not to make a profit.
Next, look at corporate taxes. GE got scorched by the New York Times, when the company paid no corporate taxes in 2010, on profits of $5 billion. Amid all the screaming about our high corporate tax rate, corporations paid only $191 billion in taxes in 2010, about 9% of all Federal revenues. Less tax means more profit.
And cheaper dollars are a simple way to get a cost advantage. With the US dollar down 15 percent from last summer’s peak, that translates into a 15 percent price cut for the rest of the world buying US products. No mystery there.
With these advantages, it’s no wonder earnings have soared. After the fact it’s all pretty simple to explain. After all, today’s announcements of record profits and record growth merely confirm what has already happened.
But predicting next year’s earnings is another story.
Because we can’t know what will happen next year until it happens, we suggest a simple strategy: Relax, stop predicting, and index.
A buy-hold-rebalance indexing approach is a surefire way to participate in markets without introducing any timing mistakes based on hunch, rumor or the advice of pundits and gurus. When you dismiss the idea of trying to outsmart the market and accept market level returns, investing becomes far less emotional and stressful. Yes, it’s possible to buy in too high on occasion, but it’s the opportunity cost of completely missing a big run up like we’ve experienced the last two years returns that can be even more costly.
It’s worth revisiting a classic chart that shows the dwindling returns of an investor who misses the best market days during a ten year period through faulty timing:
total return (%)
|Growth of $10000
|Fully invested all 10 years||12.07||$ 31260|
|Missed the best 10 days||6.89||19476|
|Missed the best 20 days||2.98||13414|
|Missed the best 30 days||-0.39||9621|
|Missed the best 40 days||-3.19||7233|
|Missed the best 60 days||-7.90||4390|
Returns for 12.31.94 -12.31.04 Source: Factset Research Systems, AIM Distributors Inc.
There will always be “experts” who preach that the market is too high or too low, that it’s time to buy or sell, or that a certain stock is ready to go through the roof. When they guess right they seem like geniuses. But just as often they end up looking like ducks in the desert, left high and dry by taking the wrong turn. With the potential cost of guessing wrong so high, I suggest a simpler approach – relax, stop predicting, and index.
This communication may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.”
“Historical performance is not indicative of future results. The investment return will fluctuate with market conditions.
Past performance is not indicative of any specific investment or future results. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor.
Investment strategies, philosophies, allocations and holdings are subject to change without prior notice.
This communication is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice.
While the Adviser believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information.
Adviser does not endorse the statements, services or performance of any third-party vendor.
Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable.
Any IPO alerts are purely informational and should not be construed as recommendations to invest.
Adviser is not licensed to provide and does not provide legal, tax or accounting advice to clients. Advice of qualified counsel or accountant should be sought to address any specific situation requiring assistance from such licensed individuals.
Any case studies or hypothetical client profiles are for demonstration purposes only. They illustrate the breadth and depth of the many clients we represent at various life stages. Any similarities to actual Adviser’s clients past or present are strictly coincidental. Individual advice and results will vary based on each client’s circumstances, objectives and prevailing economic conditions.