As we begin a new year, it seems as good a time as any to reflect on our investing habits, our financial goals for 2014 and beyond, and the current state of the markets. In the course of doing so, keep the following three things in mind:
1. Throughout 2013, there was increasing talk of U.S. equities entering a secular bull market. This was especially true once the S&P 500 (NYSEARCA:SPY) moved above its 2000 and 2007 highs. Typically, breaking above a previous secular bull market's highs after a prolonged period of time (such as the 2000 to 2013 time period) has been a catalyst for stock market prices to enter a new secular bull market. Given the S&P 500's clear breakout above its 2000 and 2007 highs, it is understandable why many commentators will claim a new secular bull market is upon us. But if that is the case, it will begin in a very different way than the last one.
In the early 1980s, when the last secular bull market began, the following was true: (1) the price-earnings ratio for the broader market was in the single digits, (2) the dividend yield was close to 6%, (3) interest rates were in the double-digits and beginning a long, multi-decade trend lower, (4) inflation was peaking and also beginning a multi-decade trend lower, (5) Americans were beginning a multi-decade process of leveraging up their personal balance sheets, and (6) the process of getting Americans to funnel money from their paychecks into the stock market via 401(k)s was just ramping up. Conditions were ripe for a secular bull market. Today, we have (1) a stock market trading with a price-earnings ratio in the mid-to-upper teens (depending on what earnings number you want to use), (2) a dividend yield on the S&P 500 just under 2%, (3) interest rates that apparently "have nowhere to go but up," (4) a Federal Reserve that seems intent on making life more expensive for Americans, despite the fact that many Americans can't handle additional increases to their expenses, and (5) what seems like a general change in the country's mood toward taking on increasing rates of debt (both as individuals and as a country).
Perhaps we have begun a new secular bull market. But what's the impetus? We do have a central bank that loves to print money, public corporations focused on stock buybacks and dividend growth, and plenty of income-seeking investors too scared to put money into bonds. Is that really enough?
2. Equity-market investors have certainly experienced handsome returns in recent years. And there are many who believe the wealth effect from those stock-market returns will help drive consumer spending going forward. With that in mind, let me share this thought as it pertains to my long-term equity-market investments. While it is true that my stocks appreciated greatly last year, the unrealized capital appreciation has absolutely no wealth effect on me. The only wealth effect provided by my stocks comes from increases in the dividends. Since I intend to hold most of my stocks for many years (perhaps my entire life), the income-generating capacity of those investments is most important to me. In my case, dividend increases will perhaps create a wealth effect, but unrealized capital appreciation will not. And for those investors who like to spend more because they have unrealized gains in their equity portfolios, keep in mind that in order to access that money, in many cases, you will have to pay taxes. Your accessible monetary wealth is therefore not as great as your brokerage account indicates.
3. It seems to have become conventional wisdom that interest rates "have nowhere to go but up." This, in turn, would put downward pressure on bond prices. In my experience, it seems the overwhelming majority of equity-focused investors view declines in stock prices as buying opportunities. But when bond prices fall or are believed to be on the verge of falling, the financial community, as a collective whole, regularly warns investors to avoid bonds. Let me provide this reminder that "buying the dip" works not only in the world of stocks but also in the world of bonds. If interest rates rise, it will give you an opportunity to increase the average yield of your bond allocation. As an individual bond investor, I welcome that opportunity.
I hope you find the aforementioned tidbits useful, and good luck in 2014!