The Independent Market Observer

11/4/13 – Change in the Weather: Colder Outside, Hotter in the Stock Market

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Nov 4, 2013 7:26:40 AM

and tagged Outlook 2013, Market Updates

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I took down a tree over the weekend, using a handsaw, branch cutters, and a ladder. I had to do it piecemeal, one branch at a time, as it was right next to my house. That’s a lot of work, and I was sweating hard by the time I got down to the main trunk and had dragged the rest of the tree to the back yard. Yesterday, when I was cutting down the remains for disposal, the weather was a lot colder. A sweater, a fleece, and gloves weren’t keeping me warm. It was a big shift from one day to the next—but hey, I live in New England.

The change in the market weather hasn’t been nearly as quick, but it has been even more pronounced. Taking a look at the market over the past couple of months, it’s clear that the narrative has changed, which probably portends continued strong performance.

I’ve talked about shifts in narrative before, how they represent a change in the way most people see something—and how that change can become self-reinforcing. The public perception of the stock market seems to have made just that sort of shift. More and more, over the past couple of months, advisors have told me about clients who are scared, but who now want and need to be in equities. It’s not that they’ve been doing badly, just that the U.S. market has been doing better—and greed has started to overcome fear.

It’s not just our advisors, either. I speak with reporters regularly, and in one exchange, I picked up this quote: “Amazing amount of retail money flowing into stocks. Not sure if we're in the euphoria stage yet, but we might be getting there.” I probably wouldn’t go that far, but hearing such a statement from a reporter who specializes in the markets, and talks to a wide range of people like me, got me thinking.

The reaction to the continued record market run-up has been twofold, generally divided between those who think the market is ready for a fall—see the Wall Street Journal article “How Frothy Is the NASDAQ?” from over the weekend—and those who think that momentum breeds further momentum, at least for a while, as shown by history. (The U.S. market has risen in the final quarter more than 80 percent of the time when there are gains over 10 percent in the first three quarters.)

My guess is that the market will continue to rise for the remainder of the year. I base that on the history cited above, on the change of narrative, and on the fact that several conservative advisors I know either have thrown in the towel or are seriously considering doing so. In the short term, that may well be the right thing to do.

I still remain concerned about market valuations, though, and a guess (note the term) that markets will continue to rise for the remainder of the year is a trading call, not an investing call. Markets are now at valuation levels in the 90th percentile (using a Shiller P/E), suggesting that they’re anything but cheap. Nonetheless, it would be foolish not to be aware of the likely short-term performance, whether to bet on it or just avoid being thrown off by it.

The thing about the weather, here in New England especially, is that it will change. Two days ago, I was sitting outside my favorite breakfast diner in shirtsleeves, enjoying the November spring weather. It’s colder now, though, and I know it will get even chillier soon. Enjoy the market warmth, but be prepared for colder weather, as it will be here eventually.

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