Provided by SanibelCaptiva Trust Company
Take note of the past 18 months: We all just experienced one of the more confounding roller-coaster markets of our careers. No doubt, investors can wipe their foreheads in relief that stock prices not only recovered all their early 2020 losses but have touched record highs consistently since November. Undeniably, too, anxiety levels have risen in tandem with the rally. In the aftermath of any recession, investors tend to fear a relapse and naturally turn gun-shy – always on the lookout for another bubble forming, even when no bubble exists.
But before you get caught up in the hype of wondering how stock prices can be so strong today – we want to lay out a few truisms that should guide your thinking:
First, markets always should move toward new highs. That is the natural course of stock prices. As long as the U.S. economy is growing, businesses are selling more goods and generating more profits, thus making their shares more valuable. This trendline of growth gets interrupted occasionally by economic slowdowns, unexpected geo-political events, or sudden bouts of panic selling, but a market moving to new highs on the back of a growing economy and rising corporate profits is the norm.
Corrections are not to be feared. A short-term stock market correction, where prices drop 10%-20%, is always a possibility and tends to happen several times a decade. But corrections tend to be fleeting and result in the market reversing itself and pushing toward its old highs again. Corrections also have been unpredictable, not only in their causes, but in their depth and duration. Trying to anticipate the next correction often results in being underinvested at the wrong time and yields poorer portfolio results.
The U.S. stock market has been top-heavy. The 18% return of the S&P500 in 2020, followed by a more than 10% return so far in 2021 has been fueled by a handful of mega-cap technology companies that today impart an undue influence on index returns. The 10 largest stocks in the S&P500 provided most of 2020’s 18% return and traded for 33x their projected earnings by Dec. 31. This gave the appearance of a stock market that was overheating and expensive, though the other 490 stocks in the index traded for just 20x projected earnings and experienced 2020 returns averaging just 4%. Top-heavy markets tend to conceal numerous less-risky opportunities below the surface.
We remain closer to the bottom of the economy than the peak. That’s a key point to consider when investors worry about future returns. We are less than a year removed from the type of painful recession and bear market that occurs once every 10-20 years. If history is any guide, the economy is more likely to provide several more years of expansion now, rather than fall back into recession. Recessions tend to cleanse excesses in the economy, lead to lower interest rates and government stimulus, and prompt consumers and businesses to take more-prudent risks with capital – events that set the stage for a long recovery.
Our clients don’t own “the market” but instead own a collection of companies and bonds that are hand-selected to achieve the absolute return goals we set for each client. The short-term oscillations and valuation levels of the S&P500 or the Dow Industrials may be irrelevant to your personal portfolio.
Finally, the stock market has been exceedingly “efficient” in valuing companies since the onset of COVID-19. Stocks that fell the most during COVID-19 were in the hardest-hit consumer discretionary industries such as restaurants, airlines, real estate, hotels, and cruise ships. Stocks that rose throughout the recession tended to lie in non-cyclical technology sectors where demand for products kept rising. Indeed, never before had America suffered a recession whose beginning and end, and causes and effects, were as easy to predict and quantify. That fact has removed many early cycle “grey areas” and given us more confidence we can locate and value suitable investments for you.
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