Market Review

If you thought the first half of the year was pretty good, you’ll be pleased to hear that the party continued into the third quarter.  The S&P 500 Index rose 4.5% during the quarter, bringing the year-to-date return to 14.2%. Foreign stocks also continued to perform well—the MSCI EAFE Index rose 5.4% during the quarter and is now up 20.0% for the year.

 

Despite the recent success, however, it is difficult to find anyone who has anything positive to say about stocks. Many think the market is overvalued, and by some historical measures, both stocks and bonds do seem expensive.

 

It is this “wall of worry” that the stock market has been climbing ever since the presidential election. Remarkably, not even the threat of a nuclear war seems to shake the faith of investors today. We do believe that the stock market is a remarkably efficient disseminator of information, but when participants seemingly become so complacent that volatility disappears, one might want to pay attention.

 

Paying attention does not mean dumping stocks and going to cash. Richard Thaler recently won the Nobel Prize in economics, and has made a career of studying irrational and temptation-driven actions among economic actors. Yet, even he does not understand why stocks continue to march higher in the face of an increasingly uncertain world. In a recent interview, he reminded listeners of December 1996, when Alan Greenspan warned of “irrational exuberance”. Thaler also reminded his listeners that the stock market didn’t care who Greenspan was or what he thought because stocks more than doubled over the following three years (before ultimately suffering significant declines in the years 2000-2002). The point being, it doesn’t matter how smart you are (or think you are), don’t waste energy trying to outguess the collective intelligence that is “the market”.

 

So, what should one do if the correct answer is to remain invested? First, make sure that you have ample cash to cover future planned purchases (like vacations and cars) as well as unexpected events (like a temporary loss of income).  Second, be in regular contact with your investment advisor so that they know your short-term and long-term goals. This will allow them to make sure your asset allocation targets are appropriate. Third, don’t take unnecessary risk. When times are good, everyone and their brother has a can’t-miss investment opportunity that they want you to consider. Be on your guard—be wary.

 

What about interest rates? If the global economy is strengthening, as evidenced by stock market appreciation, why has inflation remained so low?  One of the reasons is that most of the money created by the Fed since the financial crisis has not ended up in the pockets of the middle-class worker who might be more apt to spend on goods and services. Instead, a significant amount of this money has flowed to the affluent who are saving and, thereby, pushing up the prices of financial assets.

 

We are starting to see some evidence of wage inflation for the middle class, but the gains have been small.  Recently, interest rates at online savings banks rose from below 1.0% to 1.3%.  On the surface, that may not seem like much of an improvement, but percentage-wise, that’s a 30% increase. We have not yet seen this same type of increase in the bond market. The current 2-year Treasury yield is 1.5% and the 10-year yield is 2.3%.

 

 

YTD Performance Summary (as of 9/30/17):