For the last several months I have become increasingly wary about the rise in the market value of many publicly listed companies on North American stock exchanges. In fact, the last time I made equity investments of any significance, valuations were much, much more favorable.
I admit it has been increasingly frustrating to watch stock prices repeatedly set new highs while I sit on the sidelines. Whenever I find myself thinking "This time it is different", however, I remind myself of Warren Buffett's following pearl of wisdom:
"The stock market is a no-called-strike game. You don't have to swing at everything. You can wait for your pitch."
I do not profess to have any innate ability to predict in which direction the market is headed. I just think we should be exercising caution at this stage because there is no clarity as to what form Trump's policies will take and the extent to which his policies will be accepted by Congress.
I have not seen the details of Trump's proposed programs but am concerned the radical changes he has publicly stated he wishes to make to long standing trade agreements will reverberate throughout the world economy. If Trump wishes to play hardball, it is almost certain the world's other economic powerhouses will reciprocate. If this happens, all bets are off as to what will happen to our North American economies.
Trump has indicated the need to boost infrastructure spending to generate working class jobs. At the same time he wants to reduce taxes. If you reduce revenue and increase expenses, where does the money come from? Debt.
Rapid economic growth leads to aggressive interest rate hikes. If the US debt level increases, higher interest rates kick in, and low interest rates continue to exist in other developed countries, you will end up with a stronger US dollar. A stronger U.S. dollar puts pressure on overseas profits and creates headwinds for emerging market economies.
This would place the Fed in the predicament where it has the difficult choice of deciding whether to:
- keep a loose monetary OR
- tighten to quell inflationary pressure.
What does this all mean to us as investors? Caution!
An increasing number of traditional assets investors are seeking refuge for predictable cash flow, dividends, or distributions. These assets have been bid up to the point where their returns are no longer considered attractive or safe.
If Trump comes through with his plans to boost infrastructure spending and tax reductions, we could expect pressure on valuation multiples and the earnings growth many investors have come to expect in 2017.
I have witnessed my share of market sell-offs and one thing I have come to appreciate is the need to beware of chasing hot trends. Trends have a finite duration.