“We are at a wonderful ball where the champagne sparkles in every glass, and soft laughter falls upon the summer air, we know at some moment the black horsemen will come shattering through the terrace doors, wreaking vengeance and scattering the survivors, those who leave early are saved.
but the ball is so splendid no one wants to leave while there is still time, so everyone keeps asking, ‘What time is it?’ But none of the clocks have hands.
–The Money Game by Adam Smith
While not the most pleasant of pictures for the financial markets, if you stop and think about the quote above, isn’t this indeed what the markets have felt like over the past couple of years? A fabulous summer party after the long and desolate winter of 2008-2009? However, just as winter comes every year, so too do market corrections after extended periods of gains. In fact, on average, the S&P 500 has a 10% correction every 18 months, and we haven’t seen one since October 2011. Most strategists will tell you that stocks are “cheap” because bond yields are so low, but yields are low because bonds have experienced an unprecedented rally.Being less expensive is not the same as being cheap.
Does this mean the market can’t head higher in 2015? Absolutely not. It means that the hour is drawing late, the Federal Reserve has stopped filling the Quantitative Easing punch bowl and the dancers are growing weary. Those who leave early or protect themselves in some manner will be saved, but most investors without a plan will stay and face the horsemen in the hopes of dancing one last dance. On July 10, 2007, Chuck Prince, then CEO of Citigroup, said, “As long as the music’s playing, you’ve got to get up and dance.” Less than two years later, his company stood on the verge of bankruptcy before receiving a $45 billion bailout from the U.S. Treasury. That’s one heck of a hangover from a party that ended only three months after he made that famous statement.
Markets have averaged a Price/Earnings ratio of 15 since 1870. Currently that ratio is approximately 18; this suggests that the market could be nearing correction territory. Again, this doesn’t mean there are not pockets of opportunity, but it does mean that a broad-indexed approach is less likely to be profitable in 2015 than a targeted valuation-based approach. Those strategies, coupled with absolute return strategies, would be our recommended approach to 2015.
Best wishes for a prosperous year.