By Guest Blogger Sinan Terzioglu
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The large cap US equity market has bounced over 45% from the low set on March 23 and sits 6% off the all-time high set February 19 – about even year-to-date. Some of the largest components of the S&P 500 index such as Apple, Amazon and Facebook have made new all-time highs in recent days. This has been the best 50-day stretch ever. After experiencing the fastest 30%+ drop in history, it’s understandable people worry about another market plunge. But if history’s any indication odds are the recent gains will hold and the market will continue to grind higher.
Looking back at the previous eight best 50-day stretches for the US market since 1957, equities were higher 100% of the time six and 12 months later. The average 6-month return was over 10% and the average 1-year return over 17%. So while most believe the biggest risk is to be fully invested during big market drops, the reality is the biggest risk is not being invested for the huge market recoveries, plus the eventual longer term market moves higher.
Following the financial crisis of 2008-2009, I observed many investors doubt the recovery and cash out as the market rebounded. They sat on the sidelines anticipating another big pullback. There was volatility, of course, plus declines but none to the degree of the worst days of the crisis period. As a result, many continued to wait and missed some of the strongest years. Recently, I’ve seen the same thinking as people significantly trim their equity exposure in anticipation of another big market pull back. It reminds me of former Fidelity portfolio manager Peter Lynch’s quote, “far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections.”
Over the long term individual investors have underperformed the broad markets by a wide margin. The longer the time period the wider that performance gap gets. Too many investors are tempted to time the market when there are significant market cycles and swings. The biggest challenge for most is not to find the best performing investments or least risky ones, but rather to prevent being your own worst enemy.
While much uncertainty lies ahead, I’m confident we will get through it. For the year ahead and beyond, I continue to be constructive on the markets for the following reasons:
- Short covering: Bearish bets on US markets have been steadily rising through May. According to Canaccord Genuity strategist Martin Roberge, total short positions on US equity futures hit a record high of US$275 billion at the end of May. Short positions will eventually have to be covered meaning positions must be bought back. This could help to continue pushing the market higher.
- Negative inflation-adjusted government bond yields: Credit Suisse equity strategist Andrew Garthwaite recently put out a note saying stock valuations are set to rise because inflation-adjusted 10-year US Treasury bond yields are currently negative and likely to stay negative. Price-to-earnings ratios have climbed in proportion to the amount real yields have fallen and Garthwaite expects falling yields and therefore more upside for equities. As my colleague Ryan noted, in relative terms, stocks are very attractive relative to inflation-adjusted government bond yields. There is still a lot of cash on the side lines and much to be trimmed out of bonds and into equities.
- Resilient economy: As Garth has been saying over the last few months, the economy did not have a structural issue heading into this health crisis. The economy was turned off. Compared to the financial crisis of 2008-2009, the financial system is significantly stronger. Banks are much better capitalized. Even after setting aside over $11 billion for loan losses, the big five still have very healthy balance sheets. The banks are still profitable and dividends are being maintained. Before the virus came about, US unemployment was at a 50-year low. Last Friday’s employment numbers showed just how resilient the economy is
- Massive liquidity injections: JPMorgan expects global cash balances outside the banking system will likely increase by 17% in the coming year.
- Virus data improving: While the number of new infections remains high in the US, the outbreak is decelerating
- Credit card spending is rebounding: Visa US payments volumes in May was down 5% year over year which was a big improvement from April when volume fell 18%. Consumer spending makes up 2/3rds of the economy and there is a lot of pent up demand.
- Trump/Biden: The S&P 500 hasn’t had a down year in a US Presidential election year since 1940.
- Strong company fundamentals: The largest components of the US equity market continue to grow at above average rates and earn above average returns on invested capital.
Remember that the biggest contributor to your long term results will be time in the market, not timing the market. What matters most is your long-term risk-adjusted rate of return which is why we are such big proponents of balance and diversification. It’s natural to want linear progress with any investment but markets have never worked in a linear way and never will. There will be many bumps in the road on your financial journey but as long as you have set up an all-weather portfolio with the right mix of ETFs that are balanced and not overly exposed to risky sectors, the short term bumps will be bearable and the long term ones hardly noticeable.
In the end, how you behave is much more important than how your investments behave.
Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd.