6 Points To Consider In Today's Market

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Includes: AGG, DBP, DJP, EUFN, FXB, GLD, NFLX, SPY, TLT, TSLA
by: Eric Parnell, CFA

Summary

With stocks trading at new all time highs, it’s easy to get excited about the performance of your investment portfolio.

But rare is the story about the investor that achieved great fortunes and long-term success through emotional euphoria and swagger.

The following are six points to consider in today’s market environment in working to keep a balanced perspective in interesting times.

With stocks trading at new all time highs, it's easy to get excited about the performance of your investment portfolio. But rare is the story about the investor that achieved great fortunes and long-term success through emotional euphoria and swagger. The following are six points to consider in today's market environment in working to keep a balanced perspective in interesting times.

1. Slippery When Wet

One should never lose sign of the importance of managing risk no matter how unbreakable the market environment may seem at any given point in time. But just because you are considering the potential risks that may befall your investment strategy at any given point in time does not mean that they are actually going to happen to you. Instead, it is simply good to always be aware of the potential risks that may occur at any given point in time so that you can either prepare in advance or be ready to react if needed.

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From a different perspective, think about investing as driving down a highway. In order to help you safely get to your destination, signs are placed along the side of the road to give you instructions on how to proceed. Some of these signs provide drivers with important warnings such as "Slippery When Wet", "Winding Road", "Hairpin Curve" or "Falling Rocks". When you are driving down the road, you don't abandon your trip and head back home just because you see one of these signs. Instead, you take the warning into consideration as you continue on your trip, for it is much easier to maintain steady traction on the slippery road or navigate the hairpin curve ahead if you know in advance that it's coming. Otherwise, without knowing what might be ahead your highway drive can turn really dangerous in a hurry.

So even if you don't think there is anything to worry about in the prevailing market environment, it is still worthwhile to maintain an open mind and pay attention to the various warning signs as they present themselves. Don't abandon your trip, mind you, but don't go racing blindly down the road either. For while these warning signs may amount to nothing, they also might prove useful depending on your market driving conditions on any given trading day.

2. It's Not Personal, It's Professional

One of the things that I sometimes find notable in the comment sections is how personally and emotionally some people will respond to the content of an article. I don't find it notable because I have any objection to it, as I find it informative and interesting to read comments no matter how personally brutal or scathing they may be. Instead, I find it interesting because of what it implies about what is driving the decision making of some investors.

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One of many great things about Seeking Alpha in my view is not only the ability for contributors to share their research and perspectives on capital markets, but also the outstanding interaction that takes place in the comment section of articles. For the reader that has spent any amount of time on Seeking Alpha, they have likely come to realize that some of the most intelligent and insightful content on the website comes from the readers that express their views in the comment sections. And why I like to actively interact in these discussions as much as I possibly can is because it provides the opportunity to share ideas with those with which I agree and engage in productive debate with those with which I disagree. Sometimes I am able to effectively defend my points. And other times I am soundly put in my place. But what I enjoy most at the end of the day is to walk away from a good exchange and feel that while I might have completely disagreed with the counterpoints that may have raised, I still have great respect for this opposing view and the person that raised it. In short, I may not agree with you, and we may have exchanged solid verbal barbs along the way, but I still respect you a great deal. Such is arguably the best part of the great debate that occurs in the comment section.

It's never personal. It's always professional as it should be. For we are not delving into any particular person's character but instead exploring various individual opinions on capital markets. If it becomes personal, it suggests that emotion may be seeping into one's investment process. And emotion and investing are usually not a good mix. This is particularly true for those that feel so confident in their investment process that they feel compelled to disparage the views of others in an unproductive way. I'm not talking about sharp and stinging criticisms that are valid and warranted, because these are outstanding and often inspire the best debate even if they are downright scathing and ruthless at times. I'm talking instead about the unsupported cheap shots. Investing in capital markets is a relentless beast that eventually humbles all of its participants over time, sometimes badly and often repeatedly. Thus, if a reader is feeling so confident in their investment process that they feel free to unproductively attack and tear down the views of others, they may not have been investing in capital markets long enough to have this hubris worked off. Either that or they are among the greatest investors of all time and have earned the ability to speak with such swagger. Regardless, instead of unproductively disparaging, they may still be well served to go back and reevaluate the risk factors that they may have overlooked in their own investment strategy after firing off their salvos.

3. Sometimes It Takes Time For Events To Impact Markets

"Well, I do remember one conversation I had where I was addressing a-- a caucus of-- of congressmen. And a congressman said to me-- he said, "Mr. Chairman, you know, I'm talking to bankers in my town. I'm talking to shopkeepers in my town. And they say things are normal. Nothing's going on. We don't-- we don't see any problem." And I turned to him and I said, "You will.""

--U.S. Federal Reserve Chair Ben Bernanke, 60 Minutes, March 2009

A time once existed before the age of monetary policy day trading by global central banks when it was recognized that a change in monetary policy such as interest rates would take roughly nine months to fully work its way through the economy and markets. Today, the markets and their participants often reflect the belief that if we have not seen the impact of such changes within the next nine minutes, it likely has amounted to nothing and its time to shift our attention to something else.

But the reality still exists that just because we have not seen an immediate impact from a particular economic, market or geopolitical event does not mean that it still won't eventually feed its way through to impacting asset prices at some point in the future, potentially in a meaningful way.

For example, many investors have concluded that the 'Brexit' vote turned out to be a non event for financial markets and have moved on. But here's the thing. Nothing has actually happened in regards to the United Kingdom extracting itself from the common market other than the vote. In other words, capital markets haven't necessarily reacted yet other than European banks (NASDAQ:EUFN) and the British pound (NYSEARCA:FXB) taking a meaningful leg lower because nothing has actually happened yet. But as the latest PMI numbers out of the U.K. are foreshadowing, we may see this impact slowly seep its way in over time as the wheels of this separation start to get into motion.

So whether it's 'Brexit' or anything else that may happen to capital markets in the future, beware of being too quick to conclude that just because the market impact was not immediate that it is not going to have any impact whatsoever. For as the events surrounding the tech bubble and the financial crisis among others have repeatedly shown, the aftershocks of a tectonic market shift can reveal itself at otherwise unexpected points in time.

4. Recognize What Is Truly Driving Investment Markets Today

Many investors will attribute the relentless rise in stocks (NYSEARCA:SPY) since the calming of the financial crisis to the improvement in economic and market fundamentals. And this may indeed be correct.

But it is my belief that the primary driver of what has become the second longest bull market in history during the post crisis period has been largely attributable to the extraordinarily aggressive and relentlessly easy monetary policy from the U.S. Federal Reserve and its major global central bank counterparts. This is not to disregard the fundamental improvement that we have seen in the economy and corporate earnings since the market bottomed more than seven years ago. But I would view these forces as a distant secondary to the mega primary driver of central bank stimulus. The extremely high correlation between the S&P 500 Index and the balance sheet of the U.S. Federal Reserve since the calming of the financial crisis is just one of the quantitative examples in support of this idea.

In fact, a good deal of the improvement in the economy and corporate earnings likely would not have been possible without the zero interest rates and $4 trillion in asset purchases that have taken place during the post crisis time period. After all, if companies are able to borrow money at a low cost and use the cash proceeds to fund positive returning capital investment AS WELL AS rampant stock buybacks, such activity does wonders for greatly boosting earnings per share and lowering stock valuations in the process (if the "E" gets bigger in the "P/E" ratio, then the P/E ratio will go down). In short, take away this artificial support and stocks may be quite a bit more expensive than they already are at 25.2 times trailing 12 month earnings.

Yet stock prices continue to rise. And stocks continue to show a notable sensitivity to anything the U.S. Federal Reserve and its global counterparts are saying at any given point in time. While I have focused on stocks here, the same reality holds true for the bond market (NYSEARCA:AGG) and a variety of other asset classes. The only place where it has been notably absent in recent years is gold (NYSEARCA:GLD), but that's an article for another day.

With this in mind, it is in my view important to recognize what is driving today's capital markets. It is not investor sentiment including whether individuals or advisors are bullish or bearish. It is neither the wall of worry that the market needs to climb nor the slope of hope that it must descend. It has little to do with whether individuals or institutional investors are draining hundreds of billions of dollars on net out of U.S. stocks since the financial crisis or whether a comparable amount is pouring into bonds. And it has nothing to do with the last of the bears finally capitulating and turning bullish. Instead, the primary driver is the daily words and actions of global central bankers. Hopefully they will move to vacate themselves from this untenable position that they have assumed in the free market system. But there remains no evidence to date that they are moving in this direction any time soon.

5. Picking Up Pennies In Front Of A Steamroller Is Awesome, Until . . .

Stocks are about as expensive as they've ever been outside of the tech bubble. And if you take out technology, media and telecom stocks from the market around the turn of the millennium, stocks across the broader market are quite a bit more expensive today than they were even then. Yet stocks are showing strong determination to continue rising.

Bonds are also about as expensive as they've ever been. Treasury yields have already fallen to historic lows. And they may fall even further before it's all said and done.

In fact, just about everything is expensive in today's market with the potential exception of selected segments in the commodities (NYSEARCA:DJP) and precious metals (NYSEARCA:DBP) complex, but attempting to effectively trade around a perceived fair value in these more volatile areas of the market is a far different proposition than what is found in the stock and bond markets.

Eventually these extreme valuations will mean revert as they have throughout history. It may not be tomorrow, next month, or even next year. But eventually they will. And stocks and bonds will likely not mean revert at the same time, with the eventual correction in one likely leading to the even greater amplification and subsequent decline of the other.

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In the meantime, we remain in a market where investors are effectively picking up pennies in front of a steamroller. This can be tremendously lucrative and rewarding for investors. That is, of course, until the moment arrives when your foot gets caught under the steamroller. After that, it can get kind of ugly.

Does this mean that investors should abandon capital markets? Absolutely not, for we could continue in this slow rolling steamroller cycle for years to come. But from a prudent risk management perspective, investors may be well served at this point to avoid trying to pluck the dimes and quarters out from right under the roller - cough, cough, Netflix (NASDAQ:NFLX) and Tesla (NASDAQ:TSLA), cough, cough - and instead focusing on the nickels and pennies (and maybe the selected half dollar) that might be further removed down the pavement.

6. Remember That Stocks Are Not The Only Way To Invest

Many understandably believe that when it comes to investing you are either in the stock market or you are sitting in cash waiting to get into the stock market. For those that tune into the financial media on the color rectangle hung on their wall or sitting on their counter top, it is easy to understand why they would think this way, as stocks is the asset class that gets talked about roughly 95% of the time.

But while stocks are indeed an important asset class when it comes to managing a portfolio strategy, it is worthwhile to recognize that stocks are just one of many truly differentiated asset classes with which investors can allocate at any given point in time. And these are not throw away allocations to park your money while waiting for the next great stock opportunity. These are all meaningfully returning asset classes in their own right that provide the diversification benefit of following an entirely different returns path than the stock market at any given point in time. These include specialized yield products, various bond categories including U.S. Treasuries (NYSEARCA:TLT), precious metals, commodities, currencies, hedge products and yes even cash, as a +0.1% return can look pretty good on a relative basis when stocks are down -20% at any given point in time.

Don't go to war utilizing only one weapon in your investment arsenal. Instead, consider the entire range of options to build out a broadly diversified asset allocation strategy whose components in isolation are selected to generate positive returns and are blended together in aggregate to optimize the risk control in working to generate these positive returns.

The Bottom Line

"May you live in interesting times"

These are interesting times indeed. Whether they are cursed or not, however, remains to be seen and will remain the subject of vigorous debate going forward. But regardless of how events turn out, it remains important to not forget the principles of risk management as markets continue to soar to new all-time highs.

Just because you are enjoying your drive down the highway and should continue to do so does not mean its prudent to ignore the warning signs on the side of the road. You may even disagree that a potentially winding road or falling rock is anything to worry about, but it can still be helpful to know that the risk is still there. And if you haven't yet encountered the potential challenge on your drive indicated by the warning sign, don't lose sight of the fact that it may still lie ahead of you down the road. Also know what is actually propelling you down the road and the risks you may encounter if and when your vehicle unexpectedly and finally runs out of gas. And the best way to help make sure you arrive successfully at your destination is to use all of the resources you have at your disposal.

Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Disclosure: I am/we are long TLT,PHYS.

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.