What's next for the equity markets?

Charles T. Trible, The Daily Record Newswire

The year 2016 is off to a volatile start. As of February 4, the S&P 500 Index has lost over 6 percent on a total return basis. For the last year, if not the last few, a hot topic in the media has been the stretched valuations of stocks. Carried by “FANG” stocks (Facebook, Amazon, Netflix and Google) in 2015, the most widely watched index — the S&P 500 Index — showed narrow leadership throughout the year. This means that because the index is weighted based on the size of the companies in it, stellar performance by a few heavily weighted (large in size) securities could provide the illusion of positive overall performance. So far, 2016 has been another story, where the downturn has been relatively widespread. The key question is whether the year will continue in this fashion.

Some market historians believe in the idea that “as January goes, so does the rest of the year.” If this is the case, the stretched valuations, as shown by various P/E ratios, will shrink and show a more reasonable price per unit of earnings. Clearly this would be good news for long-term investors, as stocks would become cheaper. In recent years, companies have also become more lean and efficient through increased productivity, which has the impact of boosting their earnings with less effort. Whether through operating efficiencies or share buybacks, earnings have grown to where they are without meaningful increases in sales. Logically, it therefore makes sense that stock prices should fall because companies aren’t as innovative in the latter portion of the business cycle.

Two further telltale signs of where we may be in the business cycle are from companies’ record levels of share buybacks and dividend increases, while investing less in new projects to grow their businesses.
Acquisitions have also been fairly popular as companies are growing by methods other than pure sales. All of these conditions point to where we are in the business cycle and where we might be headed.
A business cycle can last about a decade and, in some cases, can live within secular bull or bear markets (or markets driven in large part by sentiment or events). Many argue we are in a cyclical bear market living within a secular bull market. Based on mixed economic data, this is certainly possible and, if true, certainly points to an opportunity to buy good companies on sale.

In assessing where we might be headed it is also critical to talk about commodities, and particularly oil markets. With prices so low, many companies who invested in rigs and equipment based on assumptions of stable prices above a certain level are now scrambling to pay the loans taken out on that equipment. Many fear a contagion while some, including the most well-known bond investors, are finding value in high-yield fixed income funds. Oil/energy exposure in this class of securities is less than one-third. Fear of contagion is motivating human emotions and much like equities, “the baby is being thrown out with the bathwater.”

The long and the short of the story is that ample value driven opportunities exist in today’s marketplace. When it comes to personal investing, it is most important to be well-diversified and stick to your strategy. If you can accomplish these two things, you can be reasonably successful over the long term. A large majority of personal investors are unlikely to run into what looks like a burning building when others want out. Put another way, and as stated by Warren Buffet — “be fearful when others are greedy and greedy when others are fearful.”

If you find that you cannot let yourself objectively view markets to stick to your plan and buy in downturns like some of those we’ve seen recently, perhaps you should consider a professional money manager. As with many other facets of life, discipline is a key attribute to investing and is even more important in today’s markets where it might not seem intuitive on what to do.

Over the long term, buying at significantly cheap valuations has been empirically proven to outperform those bought at valuations at significantly higher levels. So where do we go from here in equities? Although no one knows the ultimate answer to this question, an objective investor would likely rather be buying at these levels than selling out of fear, while an emotional investor might act quite differently.

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Charles T. Trible is an investment assistant for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees. Offices are located at 183 Sully’s Trail, Pittsford, NY 14534 (585-586-4680).