The Independent Market Observer

The State of the Market: Part 1

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Oct 19, 2017 12:11:41 PM

and tagged Commentary

Leave a comment

marketAfter talking about where the bubble is and then Black Monday, there is something we must acknowledge: despite all the hand-wringing, the market is high and seems to be rising even further. Like the bumblebee— which, according to all sorts of sophisticated aerodynamic analysis, cannot fly—the market doesn’t know it can’t go higher and so it does.

I have gotten increasingly interested in this scenario as it relates to the mechanics of bubbles in general and, more specifically, what we need to watch for as this bubble matures. What can we learn about what got us here, and what can that tell us about what happens next? This was the subject of my Commonwealth National Conference talk, and I plan to spend the next couple of days walking through the argument here, going into a bit more depth than the speech allowed.

The economy

The fact is that the economy is doing quite well, and it has been for years. Ditto the market. Long periods of steady growth tend to breed complacency, as well as the expectation that growth will continue.

This idea was famously formalized by Hyman Minsky, the economist who pointed out that stability breeds instability. The longer things remain stable, the more chances people take, the more bad decisions build up, and the higher the house of cards grows. Once an inevitable shock finally hits? The longer the period of stability, the greater the ultimate damage. Paul McCulley of PIMCO coined the phrase the “Minsky moment” for when that shock does hit.

We are well into a period of stability right now, and you can see the incremental growth in risk taking. You can see it in low interest rate spreads, in loosening lending standards, and in higher prices for assets. Here, houses and stocks are two good examples. We have not had a real shock in some time, despite everything that has happened. Plus, the shocks that have come have been shrugged off.

The investors

Investors, having benefited in their own lives (with jobs and rising housing prices) and in their portfolios (with steadily rising stock prices), have internalized this complacency and have acted on it. Now, the perception is that the economy and market have largely been figured out. That after the last crash, we finally sorted out the problems. Note that I am not saying that this is the case. But speaking with clients, I hear a growing willingness to take risk that reflects a sense that a new crisis is unlikely. I now have many more conversations about clients who want to take on more risk than about those who refuse to take on any.

What we’re seeing now

This complacency generates its own set of behaviors, one of which is the steady progression of markets, with very little volatility. This is exactly what we’re seeing now. Beyond this, however, it is also intertwined with a couple of other meaningful trends that have combined to push markets higher, as well as reduce volatility even further, which only reinforces the base trend. Indeed, we will talk about those other trends. First, we should take a side trip into a different area, which we will look at tomorrow. Stay tuned!


Subscribe via Email

Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®