2017 Third Quarter: 5 Reasons why the Market will Continue to Head Higher or Lower

As stocks hit record highs on a near weekly basis on the heels of the anniversary of two of the worst days in the history of the market, the question more than ever has become “how long before the next correction?”  Of course, it’s a question that many have been asking for a few years now, and one that had made those who dare answer it look a bit foolish.

The truth is, no one knows; yet some are simply reluctant to admit that.  At any given point in time there are always seemingly rational reasons why the market may climb higher, or head lower.  To prove this point, we offer 5 reasons why the market will continue to climb over the next two months and present these arguments with their opposing view.

YEAR END IS HISTORICALLY THE FRIENDLIEST FOR STOCKS

Historically speaking, the last three months of the year have been the best time for the market.  In fact, over the last 25 years, the S&P 500 has gained an average of 4.9% from October through December.  The results were even more pronounced when the market hit a high in September, and was accompanied by advance/decline line highs, as is the case now.  In those instances, the market rose 80% of the time heading into year end, averaging 5.9%.  Simply put, when the market enters October in positive territory, things usually end even better.

Let’s not forget that two of the greatest wealth destroying days ever occurred towards year-end.  The most devastating crash stock market crash in the history of the United States was marked on October 29, 1929, known as Black Tuesday, and kicked off the Great Depression which lasted a decade.  Decades later, on October 19, 1987, Black Monday, the market fell over 20% in one day.

THE ECONOMY IS STRONG

The broadest measure of economic growth, Gross Domestic Product (GDP) was up 3.1% in the second quarter, the most in over two years and ahead of the 2.8% average since 1970.  Household net worth hit an all-time high in September as rising real estate and stock prices buoyed balance sheets.  The job market is showing many signs of strength; the unemployment rate is down to 4.2% (the lowest since February 2001) and nearly double the 8.8 million jobs that were lost in the 2008 Great Recession have been added back to the economy.  The rosy employment picture has driven consumer debt payments to near 35-year lows.

But, this economic expansion is fake.  It has been created by the Federal Reserve and other central banks buying bonds and keeping interest rates artificially low which has buoyed both the stock market and the economy.  Since 2008 the Fed has added approximately $3.5 trillion to their balance sheet (it was less than $1 trillion before).  And, though the job market seems strong, there are underlying weaknesses and the income gap between high- and low-skilled workers is ever growing.

VALUATIONS

As stock prices have reached new highs through October, it would be hard to argue that prices are undervalued.  However, prices might not necessarily be overvalued simply because the market is reaching new peaks.  The most common measure to value stocks (the Price/Earnings Ratio, aka P/E Ratio) says that stocks are within historical norms.  Since 1990 the average forward P/E ratio for the S&P 500 was 16x compared with 17.7x today.  When contrasted with the 27x reading during the technology bubble of the 90’s, prices don’t seem too lofty.  Record corporate earnings coupled with near record low interest rates provide support for today’s stock prices.

Other valuation methods differ and say that the market is overvalued.  The Shiller P/E, named after Yale economics professor and Nobel Laureate Robert Shiller tells a grimmer story, looking at 10-year earnings rather than 1-year.  By this measure, the market has been overvalued for the better part of the past 20 years.

POLITICS

Yes, things have been volatile in Washington DC; there’s no denying that. One must wonder if the market will be impacted by an ill-timed tweet or a conflict with North Korea. But the market has always faced geopolitical challenges.  The S&P was up over 28% the last time our country entered a war (Iraq, 2003) and saw 5 consecutive years of gains after. We have been through impeachments, a period of over one month when we didn’t know who our next president would be following the 2000 election, and a Cold War spanning decades, yet an investment in the S&P 500 with dividends reinvested would have averaged 11% per year since Nixon was impeached.  Over the long term, corporate earnings control the market, not politics.

Things are different this time.  Nothing is getting done in Washington and the market is now assuming that politicians will come to an agreement on tax reduction, even if they couldn’t agree on health care reform.  If they can’t come to an agreement on tax reform, the market is sure to pull back.  The war of words with North Korea is escalating and the President has the lowest approval rating ever for a president in his first year.

INTEREST RATES

Historically low interest rates make stocks more attractive than either bonds or most other investment vehicles with fixed returns.  Interest rates also play a part in determining the price of stocks in the most widely used valuation methods and low interest rates support higher prices because of how future earnings and dividends are translated into today’s dollars.  Experts, including the Federal Reserve Board who set interest rates, have been calling for an increase in interest rates for years now and have been wrong.  Even if rates do rise from their current historically low levels, history shows a positive relationship between rising interest rates and stock prices when the 10-year treasury is below 5% (it is less than 2.5% today).
Rates have been slowly creeping up especially for short-term bonds, and the Federal Reserve will likely raise rates again in December for the third time in 2017.  The current Federal Reserve Chairperson, Janet Yellen, has been accommodative and supportive of low rates, but her term is up in January and the President may appoint another who might raise rates more quickly.  Rapid and steep rises in interest rates have historically hurt both stocks and bonds.

Perhaps the most famous and successful investor of all-time, Warren Buffet, once wrote “I don’t like to opine on the stock market, and I again emphasize that I have no idea what the stock market will do in the short term…”  So, it’s a wonder why so many others concern themselves with worrying about the next month’s return when most financial goals are far longer.  Attempting to time the market has never worked and never will.  If the great Warren Buffet tells us that he avoids placing short-term bets, why not just follow him?

Data Sources: Morningstar, Wall Street Journal, Barron’s, BTN Research, Dalbar, National Bureau of Economic Statistics, Vanguard: “The Added Value of Financial Advisors”, J.P.Morgan Asset Management, Department of Labor, Credit Suisse, Bloomberg Businessweek.

Written by Robert C. Votruba, Ph.D., Director of Investments, National Financial Network LLC. Registered Principal and Financial Advisor of Park Avenue Securities LLC (PAS), 990 Stewart Avenue, Suite 200. Garden City, NY 11530. Securities products and advisory services are offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America (Guardian), New York, NY. PAS is an indirect, wholly owned subsidiary of Guardian. National Financial Network LLC is not an affiliate or subsidiary of PAS or Guardian.
Opinions expressed herein are not necessarily those of Guardian or Park Avenue Securities. Data and rates used were indicative of market conditions as of the date shown. Opinions, estimates, forecasts, and statements of financial market trends are based on current market conditions and are subject to change without notice. References to specific securities, asset classes and financial markets are for illustrative purposes only and do not constitute a solicitation, offer, or recommendation to purchase or sell a security.
Data Sources: Morningstar, BTN Research, Barron’s, Wall Street Journal, Federal Reserve, TrimTabs Investment Research, Commerce Department, FactSet, NYMEX, International Energy Administration, Fidelity, J.P. Morgan Asset Management, OPEC, Financial Times
S&P 500 is a basket of 500 stocks that are considered to be widely held. The index is weighted by market value, and its performance is thought to be representative of the stock market as a whole. Small cap stocks represented by Ibbotson US Small Cap Stock Index, a capitalization-weighted index which measures the performance of US equities in the ninth and tenth deciles of market capitalization. Indices are unmanaged and one cannot invest directly in an index. Past performance is not a guarantee of future results.

Bespoke Investment Group, CFA Institute, Clute Institute, Presidents and the U.S. Economy: An Economic Exploration, Blinder & Watson., S&P Global Market Intelligence, Morgan Stanley Wealth Management, BTN Research, Bloomberg, Wall Street Journal, FactSet, Morningstar.

2017-48810 Exp. 10/19