“You can’t let down your guard... when there’s so much at stake.”
—from “Still Learnin’ How to Fly,” as performed by Rodney Crowell
Recently I read an economic piece comparing investors to people who study outdoor conditions. The gist? There are weather people and there are climatologists, and when it comes to markets, we should strive to be the latter.
This means that how markets perform daily (weather) should largely be discounted. Our main focus should be on longer term (climatology) market trends.
So what is this late stage bull market, now over nine years old, likely to do by the end of this year?
We think markets are entering what we’ll call a “cautionary growth stage.” The recent correction returned a sense of balance to share prices that may have grown, during the last calendar year, at an exaggerated pace in relation to their actual worth.
Markets can get temporarily overheated. But in addition to the fact that the tax cuts may have been “priced in twice” by investors, there are other reasons to be cautious. One is a potential slowdown in share buybacks. Simply stated, buybacks mean that companies have used profits and in many cases, borrowed cash (thanks to low interest rates) to purchase more of their own shares. Essentially, it has not only been the action of individual investors that have caused share values to soar; instead, markets have often been influenced by the companies themselves buying their own stock.
When share buybacks slow, the bull market will inevitably lose some of its steam. Several factors could cause companies to slow the buyback process.
Corporate profits may decline as wage growth accelerates. When companies are forced to pay higher employee salaries, they have less cash available to purchase shares. Rising interest rates may also be problematic. We may see as many as four rate hikes this year. When it becomes more expensive for a company to go into debt, they tend to borrow less. Fewer stock buybacks are executed, leaving individual investors to drive the market.
Spiraling corporate debt, much of it actually accumulated to execute these aforementioned buybacks, may also slow market growth, as corporations use their cash to pay down debt. Corporate debt is at its highest level since 2009. If a significant economic downturn does occur, a huge number of U.S. businesses will be loaded with debt and strapped for cash. Some will fail, causing further economic distress.
We don’t necessarily see a recession looming, but instead a slowdown in the trend of growth that characterized 2017. The bottom line is that markets have experienced so much expansion since 2009, there isn’t that much room left for share values to grow. At least not at an S&P trailing price to earnings multiple of 25.
Margaret R. McDowell, ChFC®, AIF®, author of the syndicated economic column “Arbor Outlook,” is the founder of Arbor Wealth Management, LLC, (850.608.6121 – www.arborwealth.net), a “fee-only” registered investment advisory firm located near Sandestin.