Stocks recently set all-time highs and the stars are aligned for even better days. Future stock prices depend on earnings and interest rates next year and beyond.
The earnings outlook in the second half and into next year will improve along with the economy, perhaps dramatically given record profit margins, and short-term interest rates will stay near zero for the foreseeable future.
Those are positives. Bond yields are low, which means investors aren’t worried about inflation. Gold’s decline sends the same message.
Inflation undermines stock prices because p-e multiples contract while the Fed raises interest rates, a one-two punch. It’s the most important risk for stock investors.
There is more. The euphoria always seen at market tops is nowhere to be found. In fact, stock ownership worldwide as a percentage of total assets hasn’t been this low in more than 50 years.
People don’t trust the market. The outperformance of low-volatility, better-yielding stocks is a sign that investors are most concerned about the downside risk.
They want protection and are sacrificing upside potential in growth and speculative issues to achieve it. When the reverse is true investors overpay for growth, sometimes grossly so (1999), and the market hits the skids.
Taken together, the above and other reasons — trillions in cash, buyback programs, dividend increases, strong balance sheets, unattractive alternatives — form a powerful tailwind for the market and most stocks will benefit.
As always, perhaps especially so when stocks rise sharply, one should ask “what can go wrong?” In my book, inflation is always the number one risk to stocks and the economy for reasons mentioned above, and prices are rising a bit faster now.
The Fed needs to stay ahead of rising inflation and not simply react to it.
There are other risks, too, such as stubbornly high underemployment, student debt, international hotspots, etc.
I am well aware of what could go wrong. While there are always reasons to be concerned, those are easily trumped by the many positives.
As George Will once put it, “Serious people consider probabilities, not possibilities.” Indeed.
David Vomund is an Incline Village-based fee-only money manager. Information is found at www.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.