2017 is Here - Where Will the Market Go
Today we kicked off 2017 with a continued bull market. This has been the 2nd longest bull market in history, only surpassed by the 13-year stretch from 1987 to the dot-com crash of 2000.
The bull market is turning 8 years-old soon which has people wondering how much steam is left. Optimists say that the new administration’s policies and looser business regulations will spur more growth, and in-turn continue driving prices higher. Pessimists say that the market has been falsely propped up by low interest rates and will perform a correction in the future.
Let’s analyze at both sides of the argument:
It is true that looser business regulations will encourage more growth, but the question is exactly how much more growth will we expect to see relative to the current market valuation.
The U.S. has seen roughly 2% growth per year since the 2009 recession. It’s been speculated that this can be increased to 4 or 5% with the new administration’s policies.
Warren Buffett has often said that the best indicator of market value is the total market value divided by the Gross National Product (GNP), with 75% - 90% being “fairly valued”.
Currently the ratio is about 125%, far surpassing the 90% fairly-valued threshold (this threshold was first surpassed in early 2013). It has only reached 125% twice in history – once before the dot-com crash and once in May 2015.
However let’s assume the GNP does grow at 5% per year starting in 2017 and recalculate the ratio based on that added growth.
Doing so decreases the ratio from 125% to 124%, a 1% difference only. Compounding this 5% GNP growth annually and assuming the stock market stays at its current valuation, the ratio would not reach the 90% “fairly-valued” threshold until the year 2023.
Therefore even if the U.S. hits a consistent 5% growth over the next few years and the stock market stops rising, the market would still be significantly overvalued according to Buffett’s criteria.
Considering the rampant speculation that we’re currently seeing, it is becoming increasingly difficult to believe the market has the capability of holding its current valuation.
Things get worse when you add in other factors such as investor debt relative to GNP being at one of the highest points ever, as well as the interest rate increases expected over the coming years (which do have a strong negative correlation with stock prices, as history and economics tell us). Not to mention that the U.S. economy currently already has high expectations to live up to…
I’m never one to say the sky is falling or attempt to predict an upcoming crash… however putting emotions aside and only looking at the facts being presented to us, it’s becoming increasingly clear that the market will likely take a downturn in the future. It may take weeks, months, or even years (think of how long the dot-com bubble lasted before crashing) – but all signs are pointing to a significant dip in the future.
Because of this, I have approximately 50% of my portfolio invested in bearish positions (Put options on overvalued companies, inverse ETFs on overvalued sectors and cap segments), 25% in large-cap value ETFs paying dividends, and 25% in Cash. The higher the market valuation becomes, the more my portfolio shifts out of bullish positions and into Cash. The reason being is I do not want to put much more than half in bearish positions, but also do not want to keep chasing stock prices up as the market becomes more overvalued and end up holding the bag if and when the market corrects itself.
Long-term investors have seen this familiar scenario play out in years past – rampant speculation followed by a significant correction downward. I don’t recommend putting all your money into bearish positions, but it is wise to hedge your portfolio against a downturn and be very prudent before entering bullish positions. Don’t be the same example to future generations as the 2000 and 2008 crowds were to this generation.
The stock market analysis workbook has been updated and posted to the website – check it out to see some of the data and charts that I use in assessing market valuation.