Things in the market are good. Too good.
Warren Buffett famously said, “Be greedy when others are fearful; be fearful when others are greedy.” We are seeing many “market pros” acting as if stocks will continue their parabolic rise for the foreseeable future. Many of you have followed some stocks that are also moving only upwards. Late last year, I published my thinking on why the market continues to go up despite a poor economy—because we are pumping money into the economy through stimulus and Fed support and there is nowhere else for it to go because we can’t spend it. Even if we could spend it, there are still issues with supply chains; I waited a month for a baseball glove I ordered for Black Friday to be shipped and a friend of mine can’t find a KitchenAid mixer for purchase anywhere.
The events of the last week show how this greed may be reaching its apex, with lots of individual traders using free trading platforms and leverage to drive certain names to extraordinary levels. How that situation ends up is yet unknown, but I do know that it is likely to end poorly for many. All in all, it is time to make a defensive posture, but for long-term investors who put money to work when they have it and take it out when they need it, what does this mean?
If we go back to February 19, 2020, according to Yahoo! Finance, SPY, an ETF that mirrors the S&P 500 index sat at $338.34 per share. As markets started recognizing the severity and impact of the COVID-19 pandemic, the markets fell swiftly to deal with the uncertainty, fear, and change that gripped our lives over the next month. Less than five weeks later, on March 23, the security’s value had fallen to $222.95, or a drop of over 34%. That date marked a turning point, as the Federal Reserve, having already lowered its benchmark rate to zero, indicated that they would attempt to support the economy by unlimited asset purchases on all sorts of financial assets, including assets which they had not previously been allowed to purchase. Additionally, congressional stimulus talks began in earnest.
Since March 23rd, SPY has increased by nearly 3/4ths from that March low and since the end of October is up nearly 18% through January 22, 2021. Admittedly, such volatility can be expected in bear markets. From October 2007 to March 2009, SPY declined by 60%, but rallied by over 80% from that low in the next 25 months. There are some differences this time, though.
1) The speed of the runup
The move in the earlier example took place over 3 ½ years, whereas we are now dealing with these moves over only 11 months. Even then, the 2007 level was not surpassed until 2013. We passed the February peak in August. Second is the specter of real economic recovery. In February, we were seeing record low unemployment rates and a growing economy. But even then, there were questions about the economy given the fact that the Federal Reserve had already moved into an easing phase, having lowered rates in the fall of 2019. Now, we still have nearly one million job losses PER WEEK, according to government data. This economy is not currently improving as it was in the 2009-11 period. Third, stock price valuations by all sorts of traditional metrics are at or near all-time highs, far surpassing levels seen in 1929 or 2000.
2) Public and private debt levels
We have added an extraordinary amount of debt to the overall economy over the last several years. Whether it is structural budget deficits or extraordinary measures taken on by the Fed and government to prevent economic issues through the housing crisis and pandemic, debt levels over the last dozen years have exploded. At some point, these debts will need to be repaid or the currency debased.
Further, there is accumulated debt from stores, restaurants, and individuals who have not been paying rent but have not been evicted due to the moratorium. In many cases, these deferred back rents are supposed to be paid at the end of the pandemic. What happens if they can’t pay up?
3) Interest Rates
As debt levels go up, it is likely that interest rates will have to go up with them in order to compensate for the fact that people won’t get repaid. And the alternative to higher rates for greater lending risk is higher rates due to inflation, which would lower the risk to borrowers, but would lead to lower after-inflation returns (this is what really matters) and lower stock prices. I am less certain about the effects of this in the near term, however.
I have been telling people for some time now that I expect longer-term returns to be lower than historical averages. I hope that I am wrong. Yet with the greed we have seen this month, an inflection point is likely near. So what to do in preparation?
Rebalance. Make sure that your current portfolio matches the risk you were planning on taking. Many portfolios might have been rebalanced close to last year’s lows and may be riskier now than you thought.
Stress-test your portfolio. Make sure you can still hit your long-term objectives even if your portfolio takes a significant hit.
Check your objectives. If you have a financial objective that is going to take place in the next three to five years, you need to de-risk the money that is earmarked for that objective.
I am usually more cautious when it pertains to stock prices. Some might even call me a “permabear.” But with the greed I’m seeing, I’m very fearful.
Russell D. Rivera, CFA, CFP® is the Founder and President of Voice Wealth Management (Voice) in New York, NY. He also likes to think of himself as a Personal CFO and Financial “Therapist” for entrepreneurs, young professionals, and their families. He helps clients make prudent financial decisions regarding spending, saving, investing, and planning while giving a voice to the individual client's financial priorities and experiences.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
All performance referenced is historical and is no guarantee of future results.
Past performance is no guarantee of future results. Indexes cannot be invested into directly.