The following is an excerpt from the June 3rd, 2016 Validea Hot List newsletter.
Summary: The financial crisis and Great Recession were incredibly painful events for investors, the financial equivalent of going in for a good night kiss and having your date slap you in the face Because of that, many investors have spent the last several years sitting on the sidelines, not wanting to get hurt again. Seven years of rising stocks and a steadily improving economy haven’t been enough to make them field safe enough dive back into the market. In this week’s newsletter, we talk about how the market’s year-plus pause has given those investors a chance to make their move — and why that chance won’t last forever. The Hot List is part of Validea’s Premium investment research site. Click here to learn more.
The “Hurry Up And Kiss Me” Market
We’ve all been there: You’re out on a date with someone you like. The night has gone well, and now there’s a pause in the conversation as you stand outside the restaurant and prepare to say good night. Eyes meet. Pulses pound. Should you make your move? A million thoughts and emotions seem to be rocketing through your mind. You want to move in for the good night kiss, but what if you get rejected? You’ve been rejected before, and it stinks. You don’t want to feel like that again — no way. It’s too risky. Better just go with a hug.
But you do want to move in for the kiss. And you feel good about the way the night has gone. There is chemistry here. You’re sure of it. So you summon up your courage, push your fears and bad memories of past rejections to the back of your mind. You lean in ever so subtly —
Wait — it’s not right. You swear you saw just the slightest hint of discomfort in your date’s expression. So you pause. Are you imagining things? Maybe it’s just nerves. Yes, you think, it’s just nerves. You think about leaning back in, but now it feels like the moment has passed — it’s too late, you think. You and your date exchange a polite “good night,” and that’s it. The opportunity.
It may sound strange, but I think a similar scenario has been playing out for investors in recent years. I call it the “Hurry Up And Kiss Me” market. The financial crisis and Great Recession were incredibly painful events for investors, the financial equivalent of going in for a good night kiss and having your date slap you in the face. Because of that, many investors have spent the last several years sitting on the sidelines, even as the S&P 500 has tripled. Seven years of rising stocks and a steadily improving economy hasn’t been enough to make them feel safe enough to dive back into the market.
The numbers bear this out: In 2007, 65% of adult Americans owned stocks, according to Gallup; in 2016, the number is down to just 52%, the lowest it has been in the 19-year history of the polling firm’s survey. Considering that the market has tripled over the past seven years, that’s remarkable — human beings’ tendency to focus on recent events and penchant for following the crowd usually mean that more people, not fewer, jump on the equity market train as stocks are rising.
That hasn’t happened this time around. But you know that those on the sidelines have been tempted. They see everyone else’s portfolios going up and no doubt want a piece of the action. But it seems to me that any time the momentum really starts to gain, and we get to the point where those who’ve been afraid of getting hurt again are about to come back, another mini-crisis pops up: the commodities bust, election uncertainty, interest rate hikes, the possible “Brexit”. These are the hesitant looks we see — or think we see — in our dates’ eyes that halt us in our tracks just as we’re about to make our move.
For much of this bull run, the market has offered a curt “good night” to those who have hesitated, and then it has moved on quickly to dates with other more opportunistic investors, leaving the fearful behind. But over the past year and a half, that’s changed. From Feb. 27, 2015 to June 2 of this year, the S&P 500 has moved just four hundredths of one percent (in the upward direction). Sure, it’s been up and down over that stretch, but all in all, it’s right back where it started. This is the equivalent of your date giving you a second chance — the market turned to leave, took a few steps away, and then came back and is asking, “Soooo?”
Only, in this case, our “date” — the stock market — has had some time to address some red flags. For example, those interest rate hikes that were supposed to be the market’s undoing? They started, and we have seen that the market has held up. The much-questioned economy — the underlying engine of the stock market — has pushed through concerns and continued to grow (albeit slowly). And the plunging commodities market seems to have stabilized. Given that valuations are somewhat high but not unreasonable, I think the market is offering an opportunity for investors who’ve been waiting on the sidelines to get in before the next leg up.
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The Facts
Of course, I don’t know for sure that jumping into the market now as opposed to waiting, say, 6 months or a year, will prove to be prudent. But here’s what I do know:
— Bull markets last a lot longer than bear markets, which tend to be short-lived. Since 1956, we’ve had nine full bear markets, and they’ve lasted an average of 14 months and included an S&P 500 decline of about 34%. The eight bull markets, including the current bull, have lasted an average of 58 months — nearly five years — and involved an average S&P gain of more than 140%.
— It’s incredibly hard to predict when bull markets will end. They can run for a long time after you think they’ve gotten long in the tooth. The 1990-2000 bull lasted almost ten years and included a gain of more than 400%.
— Valuations are on the high side, yes. But for valuations themselves to be the cause of a bull’s demise, they likely have to be much higher — as was the case in 2000, when the S&P traded for more than 44 times average 10-year earnings. Today, the S&P’s 10-year P/E is about 25.7 — high, but nowhere near the sort of irrational exuberance we saw in 2000. (Indeed, how could the climate be one of “exuberance” when about half of Americans don’t even own stocks?)
What we’ve seen over the past year-and-a-half is less of a correction in price than it is a correction in time; the market has paused to allow earnings and revenues — which slumped over the past year in large part because of the struggles of energy companies — to catch up to stocks. Standard & Poor’s sees S&P 500 companies’ earnings growing in Q2 and continuing on to an all-time high in Q3. If that’s the case, you can bet that the market will move higher, and the chance to give the market a kiss at early-2015 prices will be gone. (Keep in mind that, if you’ve been sitting on the sidelines, you don’t need to throw caution to the wind and go all-in on stocks. You can dollar-cost average in over a period of weeks or months if you are feeling cautious.)
In the end, there are always going to be reasons not to move in for the kiss. But I think many investors are hyperfocused on those reasons right now. In doing so, they’re remaining paralyzed, sitting on the sidelines consumed by fear. It’s easy to understand how that could happen to someone today, given the severity of the 2008 crash and Great Recession. But they shouldn’t let that trauma color all of their decisions going forward. Focus on the facts and the cold, hard data — not emotions.
When I look at the facts, I see a market with room left to run. To me, the bigger risk is not that the market will reject your advances if you make a move right now; it’s that, five, ten, twenty years from now, you’ll look back and wish you’d had the courage to pucker up.
