Is the Market Running on Irrational Hope?

Is the Market Running on Irrational Hope?

 

With coronavirus cases rising, unemployment at historic levels, and ongoing protests across America, the strong market rebound feels like it could be driven by irrational hope. Are the markets assuming there is an effective vaccine by the fall? Are they ignoring the effects of a worldwide 100-year pandemic that has killed over 650,000 people as of July 30th?

While there are certainly times when markets can behave irrationally, such times are few and far between and usually concentrated in a certain asset class or sector. At this point, with the exception of the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google), we do not see signs that the global equity markets are acting irrationally. It is important to distinguish that this belief does not mean that the market might not experience another significant downturn.

Market prices represent the aggregate predictions of thousands of professional and individual investors regarding the value of the company’s future earnings plus the book value of its assets. The operative words here are prediction and future. The stock markets typically bottom when investors have the most fear and have the bleakest outlook on the future. Historically, bottoms have typically coincided with the point of peak unemployment. A rise in the stock market does not mean that the recession is over or that it might not continue for several more years. It simply means that investors are anticipating a better future down the road.

For example, according to Charles Schwab’s analysis of data from Refinitiv, the market consensus estimates for S&P 500 companies for Q3 2020 is a -23.5% drop from the previous year. That does not seem very optimistic to me. Ned Davis and Charles Schwab recently showed that historically the S&P 500 has performed best when year-over-year earnings growth was between -20% and 5%. It seems very counterintuitive that stocks would be rising when earnings growth is negative, but again, markets are predicting the future, not what is happening at present.

Many of you are probably still wondering or worried about the market going down from here. As the future is uncertain, the answer is, unfortunately, yes, the market could go down from here. But that does not mean you should pull all your money out.

Ironically, your risk of losing money in the markets today is less than it was in January. Markets account for uncertainty by keeping prices below fair value. The difference between true fair value and the market price is the compensation investors receive for taking risk. In times of perceived low uncertainty, market prices are close to fair value and investors get little compensation for taking risk. As the pandemic has taught us, risk is always with us whether we see it coming or not. Currently, because of the high degree of uncertainty, market prices incorporate more downside risk, and investors who stay in the market are getting higher compensation for taking that risk. Taking risk is a necessary part of investing, but as investors, one of the most important things we can do for long-term success is to ensure that we are being appropriately compensated for those risks. Staying in markets when we receive high compensation for taking risk is a key part.

I would love to have a crystal ball that could tell you how the market is going to move tomorrow or next month or next year. It seems very possible that the economic recovery could slow, and the market could go sideways or take another dip. It also seems very possible that through a combination of growing knowledge, human adaptation, and government stimulus, the economic impact will not be as severe as some fear, and the market will continue its steady climb. A wide variety of data suggests that current market valuations are not irrational and that markets are appropriately accounting for the high degree of uncertainty surrounding the trajectory of the economic recovery that will ultimately occur. There are plenty of investors who are pulling money out or who are continuing to sit on the sidelines as well as plenty of buyers. Our recommendation is to continue with your target equity allocation. This approach allows you to benefit from the relatively high compensation you are getting for taking on risk right now while providing sufficient downside protection that your financial well-being is not at risk.

 

 

Disclosure: Past performance is no guarantee of future results. No client should assume that future performance of any securities, asset classes, or strategy will be profitable, or equal to the previous described performance. The S&P 500 is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the U.S stock market.

The Lessons I Learned by Not Hiring a Professional from the Start

The Lessons I Learned by Not Hiring a Professional from the Start

As many of you know, my wife and I had our first child earlier this year. As such, we’ve been slowly working on improvements around our house to make it more kid safe. One project was to upgrade our garage door openers to the 21st century to include the safety reverse sensors. To fund this project, we used the money set aside from the monthly contribution to our home improvements fund. So far so good, right?

What happened next is similar to what many people do when deciding whether to hire a professional to help them.

For this project, I decided to replace my garage door openers on my own. I had never done it before, but I convinced myself that I could do it because of the following considerations:

  • Time – I’d need to be home while the installation pro was there anyway, so why not just use that time to install them myself? Importantly, I could do it when it wouldn’t impact my wife or son.
  • Cost – I didn’t want to pay for a professional to install the garage door openers. By doing it myself, we could save our hard-earned money and put it in savings or toward other projects.
  • Privacy – I simply didn’t want a stranger in my home, even if it was only for a couple of hours in our garage.
  • Resources –With all of the YouTube how-to videos, forums, and step-by-step guides available online, I thought it would easy to figure out how to do it. Clearly, many others with similar skills had been successful.

Here’s what I learned the hard way after spending 10 plus hours on this project, without installing even one garage door opener successfully:

  • Time – The project ended up taking four times what I thought it would, without success! I wasn’t very popular with my wife as she had to pick up my slack on the weekend chores and baby duty.
    • Lesson 1 – A professional could have installed each garage door opener in 45 minutes. I could have spent my time (our most limited resource) in far better ways.
  • Cost – I ended up paying a professional to install the garage door openers. I was left with a tough choice of paying a small fortune to get them installed right away (my car was outside since I removed a garage door opener) or wait for their regular scheduling. And, I had to replace a couple of parts that I damaged (argh!) and buy a wrench set that I likely won’t use.
    • Lesson 2 – Focusing only on cost is a mistake. It’s super important to also consider the value of your time. It might have made sense for me to take on this project if it took just two hours to complete, but 10 plus hours – no way!
  • Privacy – I was anxious about this at first, but the benefit of not having to do it myself eased my mind (especially after what I’d gone through!).
    • Lesson 3 – A professional is licensed, insured, experienced, and vetted. While my apprehension may lead me to believe that having a stranger in my home is a risk, this was not the case with a professional.
  • Resources – In hindsight, all the video tutorials and guides in the world wouldn’t have made this project easier. The actual installation was infinitely more difficult than the installation videos made it look.
    • Lesson 4 – Implementing a task, project or plan is the hardest part of any process. Too often, one part does not go according to plan, throwing everything off. There’s simply no substitute for expertise.

The last consideration I overlooked, which could have been the costliest, is risk. The risks include:

  • I could have installed the safety sensors or garage door opener incorrectly, causing a family member to be seriously injured. Or, the car could have been damaged.
  • The garage door opener could have fallen on me during the removal of my old opener and the installation of the new one (especially since we didn’t have the right height of ladder as recommended in the instructions – I didn’t want to buy a new ladder).
  • I could have injured myself with the disassembly of the old garage door opener or during the assembly of the new garage door opener. Mistakes and injuries happen more often than we think with DIY projects.
  • I could have damaged major parts (beyond what I already did!), which could have cost me a lot more money. Warranties and store policy exchanges don’t protect against negligence and true ignorance.

We hired a professional to minimize these risks for our family. 

As a note: My wife recommended from the start that we hire a professional to install the garage door openers. I learned my lesson here, too! As such, I had to park my car out in the cold until my garage door was fixed. Going forward, I will forever remember these lessons because time is our most finite resource and we need to be more intentional with how we spend it.

How Much Risk Do You Need To Take?

How Much Risk Do You Need To Take?


Figuring out how much risk to take in a portfolio can seem like a simple calculation, but for most people, emotions tend to make the process more challenging. On the surface, we all know risk is a necessary component of investing, but finding the right amount of risk to achieve our goals is more complicated than just picking a number between one and ten.

There are many factors that determine how risky an investment is. (more…)

Job Offer Considerations: What’s Really Important?

Job Offer Considerations: What’s Really Important?

At Merriman, we encourage our clients to pursue a fulfilling life. This sounds great, but can sometimes be harder to achieve than we’d like. You might find yourself thinking, “If I only had more time for….”. How many times have you lamented a lack of work/life balance? While our jobs provide the means to achieve some of our goals, but at times, they may stand in the way of personal fulfilment. (more…)