The market is at all-time highs – does this mean a correction is around the corner?
The market is off to a cracking start in 2020, closing at all-time highs yesterday of 7,080 points, and up almost 6% for the month. This is an incredible start to the year and follows a great 2019, but with earnings growth trailing gains seen in the stock market the inevitable question is whether the gains are overdone and whether the market is due for a correction.
The confusing fact is that undoubtedly markets are at scary levels on a price earnings (P/E) basis, but that doesn’t necessarily mean the market has gotten ahead of itself. What makes this rally so hard to fathom is that global economies are growing slowly, and global inflation continues to lag expectations, yet equities are consistently rallying. The short answer for all of this is that interest rates are the cause. We have never seen a time with such low interest rates globally while inflation remains stubbornly low. Investors have no alternative but to invest in equities as returns in cash and bonds are so low, and these low interest rates are starting to be priced into equities for longer.
When pricing equities, one typical way is valuing the future cash flows of the business. This is particularly relevant for tech companies which have benefited so much in recent times, as they do not make much money at present, but the picture five to ten years out is a different story. In this valuation methodology, interest rates play a big role as one values cash flows out into the future using current and expected interest rates. The lower the long-term interest rates, the more valuable the expected future cash flows in today’s dollars.
It is because of this that anyone predicting doom and gloom is misguided. I’m not saying that the market will keep going up – in fact, corrections are healthy and necessary – but the current economic conditions we’re in are unprecedented so what comes next is very hard to predict. But, as famed investor Kerr Neilsen said recently, it is a far bigger detriment to long-term performance to try to pick the top rather than trimming one’s portfolio once a bull market has shown signs of falling over.
Our strategies are systematic and were intentionally designed so that we wouldn’t have to make big calls on the market. Some have defensive features (such as Momentum which goes to cash in bear markets) and some remain invested throughout the cycle, but together they offer a smooth ride over the long-term. If the current market inspires some examination of one’s portfolio, then considering whether one is appropriately diversified is always wise and we continue to recommend members take up as many of our strategies as they can justify. If your portfolio is not large enough to warrant the diversification, then it may be worth looking into our separately managed account (SMA) service. To learn more about our SMA services click here to watch an educational webinar or fill in the SMA information form below.
