Global Stock Markets Reach New Highs:
Dow 30,000? … Don’t Forget Your Umbrella!

 In Quarterly Update

As the quarter comes to a close, global stock markets have reached record highs and the Dow Jones Industrial Average has surpassed 21,000 – a number that years ago seemed would only exist in a future generation’s lifetime. Can the market possibly go higher? Can stock prices justifiably keep going up over the next few years? Will this end badly with a catastrophic decline? We believe that the answer to all three of these questions is a resounding YES!

As students of global financial markets, we understand the cycles and driving forces that send stock and bond prices up and down, often more than most novice investors expect.  As we have expressed many times, stock prices are influenced by the business cycle. When economies are growing, profits grow. We also know that throughout history, stock prices spend most of their time advancing. In fact, approximately 7 out of every 10 years stock markets post positive returns and the average economic expansion and bull market lasts about 7-8 years. It is no wonder that investors get enamored with stock markets.

However, during the handful of years that stocks do not post positive returns, those returns are astonishingly negative.  Typically, negative years culminate into 30-60% declines in stock market indexes regardless of domestic or global exposure.  It is these short, bitter and often catastrophic periods that cause investors to “fall out of love” with stocks – often to a degree that many investors never return.  It is no wonder when one simply examines the “ugly math” of declines: a 50% decline requires a 100% return to simply get back to even, which historically takes stock markets 6-8 years to generate.  Time and money are truly linked to one another.

A passive approach to investing subscribes to the old theory of buy and hold – what we call “set and forget.”  Although this philosophy works for most of the years of a market cycle as described above, it also takes the full brunt of the periodic catastrophic declines that have occurred throughout history – and will be part of our future.  As you know, our team strongly disagrees with such a philosophy and in our quest for generating great returns during market upside, we have a keen eye on managing catastrophic declines and protecting your profits.  Though risk management may not be popular in a rising market, one can mark our words about its value when markets begin their inevitable turn downward.

There is little doubt that the recent rise in global stock prices is justified.  The business cycle is recovering from a very mild (and very rare) corporate profit recession: corporate earnings are advancing significantly, particularly in technology, finance, industrial and construction material sectors. These are all signs of an early stage economic expansion and bull market. Thankfully your portfolio has significant exposure to these sectors.  The stock market is not overvalued at these levels based on many metrics – though the perma-bears and poli-market pundits out there may try to convince you otherwise.  As mentioned earlier, stock prices are based on corporate profits and the Federal Reserve – not on politics.  Based on simple mathematics it is quite possible that we could see the Dow Jones Industrial Average at 30,000 and of course we would welcome its arrival and its effect on your portfolio value.  Do we have to go to Dow 12,000 on the way to 30,000? We doubt it, but just in case we are armed with our arsenal of less than “currently” popular risk management tools – namely your portfolio’s asset allocation, sector management and the use of carefully placed stop loss orders.

In a bull market, using risk management tools is like carrying an umbrella on a sunny day: not heavy to bring along yet well worth it when unexpectedly needed!

All of us hope that you find this update and these thoughts helpful. If you have experienced any significant changes in your financial circumstances or you would like to discuss your portfolio, please let us know. As always, if you have any friends or colleagues who you feel may benefit from our services, we would be happy to introduce ourselves to them with a no-obligation introductory meeting.

Your Team at Main Street Research