Monthly Outlook: September 2021
It’s almost Labor Day and the end of summer. Hopefully, we all had a much better summer than last year during the COVID lock-down. I’m sure we’ve all experienced the classic summer road trip with family and bored kids incessantly asking, “Are we there yet?” That’s how I feel every month with markets, today. We can plainly measure and see that global stock markets are factually over-extended, over-valued, and over-exuberant. Yet, they grind higher every month with not even a five percent pullback. Earnings are back to pre-COVID, 2019 levels and equity analysts expect continued earnings growth of 25% per year. Valuation metrics like price to earnings and market capitalization to GDP are at peak levels only seen two or three times in the past 100 years. Investors seem to have supreme confidence in the Federal Reserve and their never-ending printing press and stimulus programs. It’s truly a Buzz Lightyear stock market – to infinity and beyond!
On the one hand, a perpetually rising market is great for making money and so we must stay invested. On the other hand, we know from history that these kinds of extreme markets with peak expectations and peak valuations, together, have proven to be precursors to losses. But it’s not that simple. Although every major top and subsequent decline looked like today’s market, not every over-exuberant and over-valued market results in immediate losses. If the ultimate market top is “there”, we don’t know if we’re one month or one year away. We’re on a profitable stock market road trip and we’re surely closer to a top, but no, we’re not “there” yet.
Looking for a Catalyst
To paraphrase Isaac Newton, “a market stays in motion until an opposing force changes investor psychology.” Today, the motion (or trend) is for good news to follow good news. The vaccines introduced at the beginning of 2021 have worked and the economy has re-opened and recovered. The unprecedented and massive stimulus programs from Congress and, especially, from the Federal Reserve continue unabated despite the nearly full recovery and less need for stimulus. Employment has recovered and most people that want a job can have one. House prices have skyrocketed over the past year, too, helping homeowners at least feel richer. For people with money (investors), these are good times. Like Newton, investors seem to be expecting this upward motion to continue in a straight-line fashion forever. But we know that’s improbable. What will be the catalyst or opposing force that will derail this momentum? Likely catalyst contenders could be tapering of Federal Reserve stimulus, rising inflation, earnings downgrades, supply chain disruptions, or war. These catalysts are already discussed on the nightly news. No, the catalyst is more likely to be something we do not currently suspect. That’s why we watch the news carefully for something new and unexpected. We just don’t see it yet.
We’re Skeptical Bulls Today
As money managers, we try to be “evidence-based” and invest using what we actually know. We don’t rely on predictions or guesses. What we know is that stock markets are trending higher even though they’re over-extended and over-valued. We need to stay invested and make money while the opportunity exists even though it’s increasingly risky. While we can’t guess what the catalyst will be that will eventually turn this from a bull market to a bear market, we can certainly observe the tipping point once it starts. Using moving averages, we can create a trendline for each of our index ETF holdings. This becomes our “line in the sand” to measure the tipping point from uptrend to downtrend and is our trigger to sell that ETF. It’s a systematic and unemotional way to ensure that we avoid “the big loss”, a cardinal rule for successful investing over time.
We’re currently invested in nearly every global stock market, from US Growth to International Value, and from Large Cap to Small Cap. Only Emerging Markets (mostly China) is below its trendline, and so we’ve already sold that. These various ETFs range from 13% to 2% above their trendline/sell signal. Using our iFolios strategy and buy/sell signals, we have unknown upside potential and limited downside risk. We come in every day, carefully monitor the price trends of every holding, and trade accordingly. Enjoy the road trip – we’re not there yet.