"The fish are back" is a term professional traders deploy when amateur investors return to the options and commodities markets. I was reminded of this when last Monday's Wall Street Journal had a front-page article trumpeting, "Stocks Regain Broad Appeal -- Mom-and-Pop Investors are back."
For those of us who never left, the smartest thing for us to do under these circumstances is to just assume that our stock portfolio is worth about 20 percent less than its current balance. Without touching a thing, we can prepare mentally for the inevitable so we won't do something rash or panic when it happens. When J.P. Morgan was once asked what he thought the stock market would do, he replied, "It will fluctuate." Soon enough, it will be déjà vu all over again, and with the right attitude we can just shrug it off.
But long term, the prognosis continues to be encouraging overall. In recent columns, I've pointed out that the underpinnings are there for a long-term economic boom over the next four to five years. As business cycles go, the fact is that we are slowly coming out of a recession and spooling up for more growth.
Meanwhile, interest rates show signs of remaining low thanks largely to the world's cash still sitting on the sidelines. While much is said about the Federal Reserve controlling interest rates, the hand-wringing isn't entirely attributable to the Fed because businesses and individuals around the world are sitting on record amounts of cash.
Low interest rates are the primary engine driving corporate profits and this is why longtime economic prognosticators like Ed Yardeni now side with the Trends Research Institute in predicting substantial economic growth over the next five years. Yardeni gained credibility years ago after successfully predicting a number of market and interest rate moves, so I was pleased to see him back in the news (the New York Times) a few Sundays ago confirming my positive outlook for the future.
The reason that many are concerned about what could be signs of irrational exuberance is because normal stock market performance has never had a period longer than 12 months without at least a 10 percent decline or "correction" in stock market values. At this point, we have to look back as far as 2011 to see what was then a 19 percent downdraft, so this would imply that we could be running on fumes.
On the other hand, price earnings ratios (what stocks cost as a multiple of their expected earnings) have risen only modestly since the beginning of the year. The Wall Street Journal in the article cited above said that PE ratios for the S&P 500 companies (with "E" based on analysts' expected earnings for the next 12 months) have moved from 12.6 to 14.1. In 1999, for comparison purposes, that number was roughly 100, so some would argue that we're a long way from the bursting of a bubble.
What this means to the average investor is that stocks continue to look attractive. Long term, they have always been the best investment medium anyway, so nothing has changed in that respect. Apart from the thought that we should be prepared mentally to weather a decline sooner or later, this could also be a time to consider some rebalancing.
Many investors who have been maintaining some intentional balance between stocks and bonds -- or mutual funds holding either -- would be wise to review their percentages and consider moving back to what for most older people would be the "sweet spot" of one-third bonds and two-thirds stocks. A friend in my health club stopped me the other day to point out that when he checked his balance recently, he was surprised to see that stock market performance had altered his allocation to less than 15 percent in bonds. With gains of 180 percent since the absolute market bottom in 2009, it's easy to see how things could get out of whack.
Don't overdo it, however. Remember that home equity performs more like a bond than a stock and that local housing prices have rebounded significantly. Take this into consideration when trying to arrive at a reasonable mix of investment types. The result will be a higher allocation to stocks than would have been the case if you include home equity as part of your bond allocation.
And furthermore, if you're a part of that school of fish coming back into the market, take some time to reflect on the eight market crashes we have endured since the early 1970s. Notice that the snapback effect has repeated itself in every case. This time, for your stock portfolio, consider a buy-and-hold strategy to perpetuity.
Stephen J. Butler is CEO of Pension Dynamics. Contact him at 925-956-0505, ext. 228 or email@example.com.