Current Market Levels Indicate Caution Not Panic: Part 1

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 |  Includes: DIA, IWM, QQQ, SPY
by: Chuck Carnevale

Summary

Self-directed investment portfolios are a clear and growing trend.

Self-directed investors are often faced with conflicting advice about what their best courses of action might be.

At the end of the day, it all comes down to productivity.

Current market levels indicate caution, not panic.

Introduction

Currently, not all, but most of what I write about is directed to investors that are concerned with building and managing portfolios to fund their retirement. The primary reason is rather straightforward, since I am of the baby boomer generation, I have direct empathy for the challenges facing those investors who are already retired or soon to enter retirement. However, there are other factors motivating me beyond simply being in a similar demographic.

Today, more than ever before, people are deciding to self direct the management of their portfolios. There are many reasons for this, but regardless of the reasons, self-directed investment portfolios are a clear and growing trend. However, the majority of self-directed investors have not been professionally trained. Therefore, they are hungry for knowledge and information that can assist them towards achieving their retirement goals. However, these self-directed investors are often faced with conflicting advice about what their best courses of action might be.

Consequently, their real challenge is picking and choosing among the various philosophies or strategies that represent the best course of action for their own unique goals, objectives and risk tolerances. This can be a daunting task because there are many conflicting opinions promulgated regarding investment advice. As a result, my best advice to the self-directed investor is to trust their own thinking and challenge everything that is presented to them. In this context, I endeavor to present my best thinking and simultaneously ask that each reader apply their own common sense to accepting or rejecting what I write.

However, with the above said and the appropriate caveats in place, there is one primary principle regarding making investment decisions that I believe trumps all others. I contend that investing decisions should be made on the specific merits and attributes of each individual investment under consideration. I feel this principle is especially relevant when making decisions about adding stocks to the equity portion of a retirement portfolio.

For example, when deciding what stock is appropriate for the equity portion of my portfolio, I refrain from opinions about the general level of the overall stock market and/or the economy. Instead, I spend my time and effort trying to ascertain whether or not a given specific investment, or asset class for that matter, is sound and/or appropriate for me. In this regard, I adhere to the advice of legendary investor Warren Buffett:

"If we find a company we like, the level of the market will not really impact our decisions. We will decide company by company. We spend essentially no time thinking about macroeconomic factors. In other words, if somebody handed us a prediction by the most revered intellectual on the subject, with figures for unemployment or interest rates, or whatever it might be for the next two years, we would not pay any attention to it. We simply try to focus on businesses that we think we understand and where we like the price and management." Warren Buffett

Is Our Economy Good or Bad, Strong or Weak?

One area that receives an enormous amount of financial ink is our economy and the role of government. It seems that not a day goes by where cynics are not expressing strong and usually negative views about the strength and health of our economy, and how it's only surviving because of government action, primarily by the Fed. To these naysayers, our economic future rests solely on government support and intervention. Otherwise they postulate our economy is weak and will soon crumble under the weight of government debt. These pessimistic prognosticators are fond of inundating us with numerous charts and graphs on GDP, federal tapering, interest rate levels, employment figures and on and on that they contend depict our economic demise and eventually the downfall of the stock market.

In my opinion, and contrary to what many would like us to believe, the government does not create or run our economy. Instead, I offer that our economy is driven and run by the productivity of the private sector and our free enterprise system. And, at the end of the day, it all comes down to productivity. Consequently, all the doomsayers who like to talk about Fed policy, the level of our national debt, etc., are, in my humble opinion, overlooking the true economic power of our great country and the free enterprise system it operates under. Furthermore, as I will illustrate later, I argue that much of their evidence is antiquated and not relevant to our modern economy.

As an example to illustrate my point, I offer the following article by fellow Seeking Alpha author James A. Kostohryz titled: Bubble Watch: Imagine What Would Happen If Optimism Reigned. Personally, I found the article cogent and coherently written. However, it is not the article itself that I cite, but the comment thread that followed. As if on cue, there were many comments about the Fed saving us or manipulating the market, the end of the free lunch for corporate America and other so-called macro issues. Ironically, many of these comments actually validated James A. Kostohryz's primary thesis of excessive and even unwarranted pessimism.

In order to offer an opposing position reflecting what I believe is the true underlying strength and promise of our economic future, I offer the following excerpts and my own commentary based on an article recently published on April 18, 2014 in Trends Magazine titled "Overcoming Our Economic Despondency":

"Overcoming Our Economic Despondency

According to the pollsters taking the temperature of Americans, the U.S. economy is a long way from a healthy recovery. A 2012 Gallup poll revealed that 68 percent of Americans knew someone who had lost a job.[1] A Gallup poll the previous year found that 55 percent of Americans didn't think their children would live as well as they did; that was the worst rate in the history of the survey.[2] The reasons for the pessimism are all too familiar:

  • High unemployment, which stands at 6.7 percent-but rises to 11 percent when those who are underemployed or who have given up looking for work are counted.
  • Poor return on investment for increasingly unaffordable higher education costs.
  • Rising prices for healthcare, food, and fuel.
  • Foreclosures and underwater mortgages as a result of the bursting of the housing bubble."

However, it's critical to look at the economy, and at the average American's quality of life today, in the proper context. That context must include an understanding of techno-economic paradigms.

Specifically, many people are still clinging to the "conventional wisdom" of the Mass Production era, in which businesses and individuals succeeded by:

  • Serving mass markets with standardized products and services.
  • Organizing labor (which often involved working with machines in factories) into unions.
  • Requiring both employers and employees to honor conventional employment arrangements, such as 40-hour workweeks, shared workspaces, and long-term loyalty to the organization.

Today, these approaches are no longer aligned with the realities of the 21st century economy. Success now depends on:

  • Customizing products and services to niche markets and to the increasingly demanding and enlightened individual consumer.
  • Unshackling employees from both unions and employers so the workers with the skills that are in the greatest demand are free to take their talents to the highest-paying companies.
  • Granting people autonomy over their work and their careers so they can set their own work schedules, and work from any location rather than in an office."

At this point, the Trends' article was attempting to establish the reality that our traditional methods of measuring our economic health are out-of-date. These methods so gleefully referenced by the cynics mentioned above are missing and/or failing to give proper credit to our economic health and the productivity enhancements brought to us by technological innovations expressed as follows:

"Looked at in this way, the unemployment rate - and the poll that showed that more than two-thirds of Americans know someone who lost a job - is not a symptom of a stagnant economy, but rather the predictable result of creative destruction. The 11 percent of people who are out of work and/or not even trying to find a job represent the natural shift from one type of work to another. As a result of this shift, new skills are needed, and these skills are not the ones that were in demand a generation ago."

Nevertheless, even after more than five years of powerful stock price advances and greatly improving corporate profitability, pessimism continues to persist and even prevail. No matter how good things get or are, there are many that tenaciously hold on to a doom and gloom view. Even so, I not only appreciate the reality that things are getting better, I hold supreme faith that the best has yet to come. The Trends' article crystallized my views as follows:

"In the years since World War II, most Americans have lived better than their parents did, even if they didn't rise higher than them on the economic ladder. During the 1950s and '60s, household incomes increased by about 100 percent. Even today, according to the Pew study, roughly two-thirds of Americans are earning higher incomes than their parents did at a similar age.

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That explains why the number of Americans who are considered members of the "affluent" is growing in both size and financial resources, despite the economic malaise. The 2013 Ipsos Affluent Survey USA reports that there are now 62.5 million U.S. affluents, up more than 6 percent over the past two years.[5] Put another way; 3.5 million more Americans now belong in this category.

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Ipsos defines affluents as adults aged 18 and older, living in households with at least $100,000 in annual household income. Compared to 2012, affluents' average income rose 4.6 percent to $200,200, their liquid assets soared by 9.1 percent to $551,400, and their net worth increased 2 percent to just over $1 million."

At this point, I would like to state that my purpose in writing this article was not to criticize those with an opposing view. I hold no animosity to those that are cynical about our economy or pessimistic towards it. All of us are formulating our opinions based on the information that is readily available to us. Unfortunately, there are no good-news-newspapers because good news doesn't sell papers. Consequently, it is often very hard to find articles or information supporting a positive outlook on our future. Therefore, in the spirit of balance I feel it is important and proper to at least acknowledge that there are strong reasons to expect a bright long-term future. This holds true not only for America, but for the entire world. Again, I turn to the Trends' article that says it better than I:

"Economist Arnold Kling points out that when one considers how well most Americans live today, it's clear that GDP statistics lead to unnecessary pessimism about the economy.[6] It's not so much that the economy is in bad shape; the problem is that we don't have an accurate way to measure how much the economy has improved. GDP statistics were originally designed to measure the output of an economy that produced tangible goods, such as tons of steel or bushels of wheat. But much of the value generated for consumers today is intangible, especially in the area of enhanced social welfare through gains in what economists call "consumer surplus." Consumer surplus is the amount by which the actual value of a product or service exceeds its cost. For example, a song downloaded from iTunes to play for a couple's first wedding dance is worth considerably more to that couple than the $1.29 they paid for it. An even better example is all the free content, from YouTube videos to news articles that can be accessed for free on the Internet. All of that content creates value beyond its cost to the consumer, which is zero. All of it is consumer surplus, and none of that value is measured as part of GDP.

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Kling estimates that consumer surplus is actually worth many times the GDP that economists measure. Appliances such as washing machines, dishwashers, and microwave ovens; electronic devices such as televisions, computers, and music players; and amenities like air conditioning, indoor plumbing, and WiFi all deliver much more value to people than the cost they pay. Another often-overlooked aspect of consumer surplus is improved medical care. Advances in drugs and healthcare treatments that cure diseases, relieve pain, and extend lives are all worth far more to consumers than the actual cost to purchase them.[7] Kling quotes economists Kevin Murphy and Robert Topel, who calculate that "Cumulative gains in life expectancy after 1900 were worth over $1.2 million to the representative American in 2000, whereas post-1970 gains added about $3.2 trillion per year to national wealth, equal to about half of GDP." Again, none of that consumer surplus is included in GDP."

There is a lot more to consider regarding our economic health than outdated GDP calculations. All we need to do is look around our homes and offices to see evidence everywhere. People today live better, healthier and more prosperously than ever before. Consequently, I suggest that we count our blessings and accentuate the positive aspects over the negative aspects of how people truly live today:

"Also, Americans' homes are filled with electronic devices that were not only unheard of in their parents' generation, but are also incredibly cheaper compared to the state-of-the-art products of the past. The "American Enterprise Institute blog Carpe Diem recently compared a "moderately priced" stereo system featured in a 1964 Radio Shack ad to the devices that the same amount of working hours would purchase today. The 1964 stereo system was priced at $379.95, which was a discount from the regular price of $483.30.[9] Given that the average hourly wage in 1964 was $2.50, it would have taken 152 hours - almost an entire month's worth of 40-hour weeks - to pay for the stereo system. To understand how much living standards have improved, let's compare what 152 hours' worth of work would buy today. At the average hourly wage of $20.39, that amounts to about $3,100. Before we go further, let's pause to make the point that the difference in purchasing power today doesn't derive merely from wage increases. The 1964 stereo, adjusted for inflation, would cost $2,855 in today's dollars. So if nothing else had changed, the 1964 stereo system would cost about the same amount of money, in working hours, as it did 50 years ago. But something has changed. The relentless march of innovation has created products that are not only light years ahead of those in 1964 in quality, but also vastly cheaper in price. With $3,100 - the same amount of money for the same amount of working hours it would have taken to afford the stereo system in 1964 - an American today could purchase the following 12 items:

  • A Yamaha 500W 5.1 3D Home Theater System for $400.
  • A Sharp 50-inch LED HDTV for $500.
  • An Apple 16GB iPod Touch MP3 Player for $215.
  • A Sony Smart 3D WiFi Built-In Blu-ray Player for $250.
  • A Sony 5-Disc CD Changer/Recorder for $150.
  • A Garmin Portable Car GPS with lifetime map updates for $140.
  • A Canon PowerShot SX500 16.0-Megapixel Digital Camera for $240.
  • A Dell Ultrabook 14″ Laptop with 4GB Memory and 500GB Hard Drive for $650.
  • A HP Photosmart 7520 Wireless All-In-One Printer for $150.
  • A TiVo Roamio DVR for $150.
  • A Kindle ereader for $100.
  • An iPhone 4 8GB without a contract for $160.

It's not just that the typical American in 1964 could not have afforded the items on this list. What truly indicates that Americans' wealth has expanded is the fact that even the richest people in the world of 50 years ago could not have bought any of these devices because they had not yet been invented."

Summary and Conclusions

I believe that people living today have much to be grateful for regarding our economic health and prosperity. But more importantly, I believe that our future is filled with incredible promise and opportunity. Nothing I have written in this article is meant to imply that there are no problems in the world or with our world economies. Because, in truth there always has been problems, and there always will be. However, I often think back on the advice from one of my favorite high school teachers.

This remarkable lady would never allow us to say we had a problem. Instead, she insisted that we only faced challenges, and that challenges are solvable and simultaneously opportunities for us to grow and learn.

In this part one of a two-part series, I simply presented the contrary notion that economically speaking, things might be better than many of us perceive. In part two, I will present evidence of the current stock market level in the general sense, and more specifically at individual common stock ideas that are attractive today. Both of these articles are designed to support my thesis that current market Levels indicate caution, not panic.

References

1.For additional information on the 2012 Gallup poll about job loss, visit their website.

2. The Wilson Quarterly, Summer 2012, "The Withering of the Affluent Society," by Robert J. Samuelson. © 2012 by The Woodrow Wilson International Center for Scholars. All rights reserved.

5. To access The Ipsos Affluent Survey USA, visit their website.

6. The American, February 2014, "GDP and Measuring the Intangible," by Arnold Kling. © 2014 by American Enterprise Institute. All rights reserved.

7. To access the paper "The Value of Health and Longevity," visit the National Bureau of Economic Research website.

9. Carpe Diem, February 26, 2014, "The 'Good Old Days' Are Now. Thanks to the 'Miracle of the Marketplace,' a 1964 Stereo = 12 Electronic Items Today," by Mark J. Perry. © 2014 by American Enterprise Institute. All rights reserved.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.