Sound Fundamentals
Why does the stock market keep going up and setting new highs when there is so much turmoil domestically and internationally? That’s the most common question we hear from advisors and clients and it comes up in almost every single discussion. Despite all that political turmoil, economic fundamentals remain outstanding. The economy keeps producing jobs in abundance, corporate profits are rising rapidly this year and another solid advance is expected next year, interest rates have increased, but remain low, and wage and price inflation have not increased alarmingly despite the solid growth. Moreover, stocks are inexpensive. Why shouldn’t stock prices continue their measured pace of increases?
Most of what consumes the public is the incessant, highly fractious political turmoil that fills the media’s 24/7 needs. (While the media hates Trump, it owes him plenty for keeping eyeballs glued waiting for the next shoe to drop. Viewership remains elevated.) But this is really just a side show to what matters to the stock and bond markets. Unless people become so obsessed with the ongoing political show that they forget to go to the supermarket, the auto dealership, and the shopping mall, the underlying driving force behind the stock market—corporate profits—should propel the market even higher over time. And if consumers and businesses are a bit more cautious because of the political turmoil, it helps prevent the economy from overheating. As long as the economy continues growing, stocks should continue rising.
Even so, stocks remain rather cheap, as noted in David’s Investment Commentary last week. Excluding a few FANG stocks, the rest of the market now trades at slightly more than 13 times 2019 projected earnings, a rather depressed value consistent with an elevated level of fear by investors. The market’s valuation suggests people really are distracted by the political craziness, which is why that multiple is so low. And there’s plenty of cash on the sidelines because many investors are so concerned with this environment they’d rather hold cash that earns peanuts. But this also means they have missed a good portion of the rally, so any “correction” or market setback provides an opportunity for these people to get in. Between all the cash frustrated by failure to participate in the rising market, the modest valuation of the typical stock, and the solid growth of the economy, corrections should be brief and shallow, which has largely been the case. There’s simply too much value in the stock market for a deeper decline until economic fundamentals deteriorate.
Stocks don’t live charmed lives and conditions can turn unfavorable. The job market is getting tighter, wage inflation is picking up slowly so far, and interest rates are rising. All parties, no matter how good, end at some point. But it is too facile for a few voices to project a recession in 2020, since that is well beyond our predictive capabilities. (They rely on the fact no one will even remember their forecasts by then.) Right now, the economic radar screen is mostly clear of problems. (How the battle over tariffs and trade plays out is yet to be determined.) Until economic conditions weaken, the path of least resistance for stocks remains upward.
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