Since I write a lot about personal finance on this website, and I’ve written hundreds of articles on investing on other sites, I frequently get questions about investment advice. My advice – to the extent that I even give it – is very guarded, and always framed with generous disclaimers. The fact is, I have no idea specifically how anyone should invest their money. I have even less inspiration as to where the stock market is heading. It seems to be in a certified mania, which is why the Dow could hit 30,000. That kind of market is never a solid basis for giving out investment advice, if I were even disposed to do so.
This article represents sort of my official general investment advice for anyone who asks. It’s actually inspired by a recent exchange with reader Kevin B on the Everyone Talks About Retirement But Few Will Ever Retire. I’ve been avoiding this topic for a couple of years, but Kevin B’s comment made me realize that it’s time to take it on.
If you’re hoping to get any investment strategies from this article you’ll be completely disappointed. What I’m going to express more than anything else is why I think the market has gone as far as it has, why I think it may go much higher, and why I think that’s not necessarily a good thing.
The Current State of the Stock Market
The Dow Jones Industrial Average (the “Dow”) has staged a spectacular rally from a near-term low of 6,547 on March 9, 2009 on the heels of the Financial Meltdown. To be fair, that was an exaggerated low, given the circumstances of the time. But this point shouldn’t be given too much significance.
The market has roared back to its current level of 23,000+ (and rising), coming very close to quadrupling in a space of just 8 ½ years. That’s extraordinary growth when you consider that the fundamental problems with the economy have not been fixed since the meltdown.
Even the increase from the pre-Financial Meltdown all-time high of 14,164 on October 9, 2007, is extraordinary considering the economic stagnation (at best) that’s taken place since. It represents a peak-to-peak increase of 62%, which doesn’t seem justified by the stagnation of the past 10 years. In fact, by a number of measures, the economy was better in 2007 than it is in 2017.
And let’s also not forget that the previous stock market peak was itself the top of a hyper-extended bubble. That’s why it crashed the way it did.
This Market is Plagued by Weak Fundamentals
Very little about this market makes any sense from a fundamental standpoint. Its rise can’t even be justified by steadily increasing corporate profits, because they too have mostly stagnated over the past five years at around $1.6 trillion per year.
The current price earnings ratio of the market, based on the S&P 500 collectively, is currently 25.74, versus a median historic level of 14.67 and a low of 5.31. That indicates that this market is trading at the upper reaches of its historic range (the all-time high was 123.73 in May 2009, after the Financial Meltdown obliterated corporate profits).
Market “experts” can crow about strong fundamentals all they want but the facts don’t support the claim. When you hear that kind of talk, it’s mostly market hype. Or people who believe that economic history only began in the spring of 2009.
Does that mean that we’re on the precipice of a stock market crash? Possibly – but probably not. That’s why the Dow could hit 30,000, and why I don’t like to give investment advice.
What’s Driving this Market – and Why the Dow Could Hit 30,000
Okay, the stock market is in a bubble. That’s the basis of why I’m saying that the Dow could hit 30,000. It can reach that high, and higher, for all the same reasons that brought it to 23,000+.
As I outlined in my comment response to Kevin B, here are the “forces” that I believe are driving this stock market, and why the absence of more solid fundamentals aren’t a factor.
In an article published last week on Casey Research – Why This Record-Breaking Market Should Terrify You, Justin Spittler and Joe Withrow warned that the CBOE Volatility Index (VIX) is currently sitting near record lows.
The VIX is often referred to as the fear index. That’s because it measures expected volatility in the financial markets. When the index is high, it indicates a high level of investor fear. When it’s low, it indicates low levels of investor fear.
The current level of the VIX is indicating virtual complacency among investors about the stock market. That’s considered to be a contrary sign and very bearish. Among other things, it could mean stocks will crash on really bad news. At that point, the confidence that’s driving this market could crash, and pull down the whole house of cards.
But up to this point, investors have been reliably ignoring even really bad news.
So we have this record stock market – setting new ones practically every week – and no one appears to be the least bit worried that it might be tracking too high to be sustainable.
Let’s move on…
We all learned about inertia in school. It’s objects in motion stay in motion, objects at rest stay at rest. The stock market is clearly in motion, heading ever higher. It will keep going higher until a Major Ugly Event disrupts the complacency and inertia, and sends it heading in the opposite direction. Until then, it’s full speed ahead.
Inertia means that the stock market is rising because the stock market is rising.
Believe me, it’s not semantics. To understand why it works the way it does, you’ll have to do a deep study of human behavioral psychology. (Hint: start with the herd mentality.)
Artificially Low Interest Rates
This is a stock market driving force that I’ve written about several times in the past, but it’s the most important driver. With short-term interest rates on safe investments below 1%, investors are more than willing to take a chance on double-digit returns in stocks. The puny returns on fixed income investments embolden investors to ignore risk in favor of higher returns, even if those returns are the result of pure speculation.
Until we get a significant increase in interest rates, which the Federal Reserve seems entirely reluctant to usher in (and for very good reasons, too involved to discuss here), the market should continue to power forward.
Corporate Stock Buybacks
Once illegal as a stock price manipulation tool, corporate stock buybacks have become standard corporate operating procedure in recent years. Companies are spending more money buying back their own shares than they are for innovation or research and development.
This practice has a significant impact on stock prices. When a company buys back its own stock, it reduces the amount of stock in public hands. That has the general effect of increasing the price. After all, the less there is of any item or commodity, the more valuable it becomes.
But while it’s happening, it results in unmerited (based on fundamentals) increases in general stock prices. It makes corporate executives look more intelligent than they really are, and the companies themselves appear more successful. It also doesn’t hurt corporate executives that the increase in share price provides handsome returns on their stock options.
But a company buying back its own stock is akin to a farmer eating his seed corn. In the short run, he may have more to eat. But in the long run, he eventually runs out of seed to plant to grow more corn. This is another indication that the fundamentals of this market are completely suspect.
The Exchange Traded Funds (ETF) Phenomenon
ETFs primarily invest in markets and market sectors. For example, the most popular type of ETF is one that invests in the S&P 500. These are referred to as index funds, because they are invested in an entire market, rather than a select group of stocks.
From an investment standpoint, they’re the perfect low-cost passive investment. Since they invest in entire markets, there’s very little stock trading in the fund. This means that the investment expenses associated with the funds are much lower than mutual funds, which are actively managed (traded more frequently). The ETF fund manager attempts to match the performance of the market or market sector, but not to outperform it.
ETF’s are being promoted as a relatively risk-free way to invest in stocks. In the past eight and half years they’ve looked like mutual funds from Heaven. They’re tied to markets that have gone straight up, without much more than a 10% correction.
The public has been convinced that these funds generally go up, if only because that’s been the recent experience. For that reason, they faithfully and consistently pour more money into them. Mostly this happens through automatic investing payroll deductions into 401(k) plans, IRAs and other long-term investment plans. This means that money keeps pouring into markets.
As successful as ETFs have been in the past few years, the reality is that they represent people investing in markets, rather than in individual stocks. In truth, the performance of individual stocks no longer matters. People are investing in markets, not stocks. As long as those markets continue to increase, investors keep pouring more money into ETF’s.
It’s a classic case of money chasing money, with no reliance on sound fundamentals whatsoever.
Supreme Faith in the Man-made god Known as the Federal Reserve
The US Federal Reserve maintains the integrity the banking system, directs interest rates, and acts as banker to the US government. To do that, the Fed is equipped with a very powerful tool – it can create money out of thin air. Like the Banker in Monopoly, it never runs out of money. It was created by the federal government in 1913, and it was officially given this power.
Because the Fed can create as much money as it needs to, the US government and virtually the whole US economy fully rely on it to manage the entire financial system, and by extension, the entire US economy.
You know those “budget battles” on Capitol Hill that happen about every two years, and threaten to shut down the government? They’re pure theatrics. The government isn’t going to go broke because it can’t balance its budget. It can borrow as much money as it needs to, and if it can’t sell its bonds, they will be purchased by the Fed. And since the Fed is a virtual bottomless pit of money, there’s virtually no limit to how much the US government can borrow.
Politicians are aware of this arrangement, and that’s almost certainly why they’re not really worried about the budget, or for that matter the US economy.
That confidence in the Fed has filtered down to corporate America and individuals. People generally believe the Fed to be so powerful that it’s virtually godlike. And since the Fed has been squarely in the corner of a rising stock market since at least the 1980s, investors have supreme confidence the stock market will continue to levitate higher.
There’s even a Wall Street saying for the phenomenon: Don’t fight the Fed.
And the entire investment community said AMEN!
The New Religion of the Stock Market Rising Forever
A Stock Market Rising Forever has become a new religion, and the Federal Reserve is its god. This is another central point that I made in the comment to Kevin B:
“The stock market, mania that it is now, has a religious following that’s virtually cult-like. If you challenge the fundamental integrity of the bull market, you’re messing with people’s religion. A lot of financial futures are predicated on the idea of double-digit returns forever, and people don’t take kindly to alternative thoughts, regardless of how well-thought out they might be.”
I’m taking the vain liberty of quoting myself here because I can’t possibly improve on that observation. Right now, millions of people are anxiously anticipating early retirement in five or 10 years, based on perpetual double-digit returns from stocks. They cannot be objective in assessing the reality of the market. They represent a core of faithful believers/investors/apostles, who will continue to pour every last dollar into the market, in the hope of making their dream a reality.
And if you ever ask what you should do with your money, they’ll faithfully proselytize that you must plow it into the market without reservation. If you disagree or challenge their assumptions, they’ll react like an angry preacher.
Believe me – I’ve been on the receiving end of their tirades more than a few times.
How Should We Invest in a Mania-Driven Market?
The short answer is I don’t know. The conventional wisdom is to continue riding the elevator up. There’s actually some merit to that recommendation.
This market will fizzle out at some point, but nobody knows when – certainly not me. Nor am I going to venture into predicting when it might happen or what the cause will be.
The Dow could hit 30,000, and a lot higher. That’s why as much as I’m hesitant about this market, I would never bet against it. It makes sense to have at least some of your money in stocks right now. But I would avoid jumping in wholesale, under the assumption that you will get rich in a few years. Always remember that there’s intelligent investing, and there’s raw speculation. When you invest at market tops, it’s closer to raw speculation. That’s about where the market is at right now.
A good friend of mine, a gentleman much older than me, told me an unfortunate story about his own father. His father made a lot of money investing in real estate. It was what he knew best. But by 1928, the stock market reached such levels and had become such a widely accepted mania, that he sold all of his real estate holdings and invested the money in the stock market.
As we all know, stock market crashed in 1929. By 1932, this man was broke. My friend also believes that it led him to an early grave, just a few years later.
This is what can happen if you invest everything at a market top. That’s why I think this approach should generally be avoided.
Invest With Extreme Caution
If you want to get into this market, do it with a minority percentage of your portfolio. And do it gradually. Use the the dollar cost averaging method, in which you invest regular amounts of money in the market periodically. By doing this, you won’t get crushed in a major market reversal, the way you almost certainly will if you plunge in with reckless abandon.
Sure, returns on fixed income investments are pathetically low right now. But at least they’re safe. Wait until the market has a major reversal before getting in with larger amounts of money. No matter what the self-made Oracles of the Market will tell you, the reality is that the market crashed three times in the past 30 years – 1987, 2000-2002 and again in 2007-2009.
That can’t be ignored.
Anything that’s happened with that kind of frequency is destined to happen again. It’s even more likely in the aftermath of manias, since they drive values to unsustainable levels.
I believe that the best strategy right now is to “keep your powder dry”. Hold most of your money in cash and wait for the major market reversal. When that happens, summon up the courage to buy into the market. That’s when potential future returns will be much greater and more predictable than they are now.
That’s all pretty vague advice. But I think it’s the only approach that makes sense given current exaggerated valuations.
Any thoughts or counter opinions? What would you tell someone to do with their money now, if they are a…
- Young person just beginning to invest?
- A person in retirement?
- A person just a few years away from retiring?