Maintaining Portfolio Conviction
Contributed by Doug Walters, Max Berkovich
US stocks slipped a bit this week, falling about 1%. After rising 100% from the pandemic lows, I suppose we can forgive Mr. Market for taking a breather. Yet after such an increase, are stocks getting too expensive?
Equities are undoubtedly expensive relative to history. However, that does not mean one should pack up their portfolio and run for the hills. To do so would be market timing, which can be one of the most damaging actions an investor can take. Take the example of last March. In the darkest hour of the pandemic (from a stock market perspective), many nervous investors, fearing a prolonged downturn, exited the stock market. On March 23rd, 2020, the S&P 500 closed at 2237. The next day, the index jumped over 9%. For the nervous investor, missing that one-day bounce caused permanent portfolio damage. Let’s investigate that a bit further.
Assume an investor had $1M in stocks and got out of the market on March 23rd. On March 24th, they would have missed out on a 9.4% return… a $94K missed opportunity. Now let’s say they get back in the market on March 25th. From that point to today, stocks are up 82.0%. That $94K mistake just grew to $171K ($94K x 1.82) and will keep growing as long as the stock market continues to produce positive returns. The lesson here is that investing mistakes are permanent, and worse yet, they compound over time.
So how do we approach an expensive equity market without market timing? First, an evidence-based investor must concede that the future is unknowable. Stocks may fall, they may trade sideways, or they could keep rising. But we are not helpless. Rather than predict, we prepare. Good preparation includes:
- A portfolio with intelligent diversification in liquid investments.
- Securities with proven attractive factors (Quality, Value, Momentum, and Size) at the core. With such an approach, it is possible to construct a portfolio with attractive long-term return prospects and is not as expensive as the broader market.
- An eye on opportunistic rebalancing. Research shows that allowing assets some freedom to drift but often checking for a need to rebalance is best for taking advantage of market moves (i.e., systematically buy low and sell high).
One certain thing is that the stock and bond markets will rise and fall unpredictably. Success as an investor is less about these ups and downs and more about preparing and maintaining conviction in your portfolio.
Core CPI inflation
Inflation jumped 0.9% in June compared to a 0.5% expectation. Core CPI is now 4.5%, the highest since 1991. The Fed still sees inflation as transitory.
Pricing Pressures
Inflation remains a big point of focus, and this week the Consumer Price Index (CPI) provided the latest data point.
- Inflation jumped 0.9% compared to a 0.5% expectation. Core CPI is now 4.5%, the highest since 1991.
- Much of the increase was due to used cars again, which jumped 10.5%.
- Even still, removing the base effect (i.e., low prices this time last year) and outliers like used cars, there still is general upward pressure on inflation. The “trimmed-mean” CPI, which excludes outliers, is up 2.9%, and the “median” CPI is up 2.2%. These measures give a better sense of the true underlying pricing pressures versus the Fed’s 2% average target.
- The Fed Chairman remains confident that the current bout of pricing pressures is temporary.
Earnings Boom
Earnings season kicked off in earnest this week, with reported growth coming in much higher than expected.
- Second-quarter earnings for the S&P 500 companies were forecast to be up 52% compared to the same period last year.
- With the first 8% of companies reporting a combined 129% growth, estimates are now for total growth closer to 70%.
- JPMorgan’s CEO struck a positive tone noting that with their house prices, wages, savings, and investments all up, consumers are “raring to go.”
Building Bills
Infrastructure remains in the headlines, with the Senate majority leader pushing for action next week. Two bills are in play.
- The first is the bipartisan proposal focused on traditional infrastructure like roads and bridges. 60 votes are required to move the bill forward.
- The second is a $3.5 Trillion proposal focused on human infrastructure, including a broad list of expanded family benefits, such as medical leave, child care, and affordable housing. The bill is being advanced via reconciliation, which would only require a simple majority.
- Perhaps investors are too soon in sounding the alarm of peak stimulus?
Delta Blues
Covid cases are on the rise again, including in the US.
- As the delta variant takes hold, new cases in the US have more than doubled in the past 5 weeks.
- Florida, for example, has seen cases rise from a 7 day average of 1,200 to 5,600.
- While the US is ahead of many other countries in terms of vaccination rates, many states with a low percentage of the population vaccinated will be vulnerable to this next wave.
- A stall to reopening efforts could potentially put pressure on Value and Small-Cap stocks.
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