In recent Money and Markets columns, I presented a number of specific reasons why the market is due for a pullback.
To support that point of view, I have indentified several factors such as:
- Stretched Valuations — Both the Shiller P/E ratio and the stock market capitalization as a percentage of GDP are at lofty levels.
- Lack of Economic Growth — Real GDP growth in the U.S. has averaged just 1.8 percent since 2000, which is about half the average for the previous 100 years.
- Debt Levels Remain High — Private household debt has declined, but government dept has skyrocketed.
- The U.S. Consumer Is Struggling — U.S. consumer spending accounts for about 70 percent of U.S. GDP, and real median household income has been on a dramatic decline since 2007, currently standing at 1995 levels.
- Margin Debt Is Peaking — Margin debt on the New York Stock Exchange is approaching a level that has historically coincided with a correction in the stock market.
But any experienced investor knows there is always a different perspective to be considered when looking at the financial markets. After all, that’s what makes markets function properly, because for every buyer there is a seller on the other side of the trade. And the most successful investors I know gain an understanding of both countervailing points of view before making their own decisions.
|Any experienced investor knows there is always a different perspective to be considered when looking at the financial markets.|
So here are the primary counterpoints to the position that the stock market is due for a correction and instead may be headed higher.
- Valuation measures are unreliable timing indicators — While valuation measures can provide useful information about long-term future returns, their historical record for identifying exact market peaks and troughs is poor.
- Valuations have been higher in the past — Although current valuation levels are high, they have indeed been a lot higher: Specifically in the late 1990s.
- Recent signs of economic growth — Last week, there was encouraging news when second-quarter GDP was revised upward to 3.6 percent.
- Don’t fight the Fed — The Federal Reserve has the world’s reserve currency as its primary weapon, and they are determined to continue to provide whatever liquidity is necessary to get the economy moving again. As long as the Fed’s easy-money policy is in place, it will propel the stock market higher.
- Pension plans have to own stocks — Because of underlying actuarial assumptions, pension plans, which control trillions of dollars of investment assets, are forced to own stocks to meet their pay-out obligations, thus providing a huge market demand for stocks regardless of their price.
- Americans’ debt burdens have been reduced considerably — Household debt payments as a percent of income are now the lowest they’ve been since the early 1980s. In fact, American households will spend almost half a trillion dollars less on debt payments in 2014 than they would if debt hadn’t declined over the past five years.
So there you have it, the arguments for both sides of the same coin. Ultimately, it’s your decision on which side you want to be. And that decision should be as much related to your own financial and risk profile as it is to your psychological make-up.
For me, I see it as a matter of sequencing; meaning, I believe the Fed has enough firepower to keep the stock market elevated a bit longer. But sooner rather than later we’ll have a significant pullback. And that pullback will finally purge the financial system of all the toxic assets that have accumulated over the past two decades, setting the stage for a new golden age of stock market investing that will extend for a long time.
All in all, market timing is tricky business. That’s why I continue to recommend you consider building the core of your portfolio around large global franchise companies that pay a dividend, such as United Technologies (UTX).
That way you profit either way: If the stock market continues to go up, you’re in the game with investments in high-quality companies. On the other hand, if the market corrects significantly, you get paid to wait for the next big run I see coming in the years ahead.