My Contrarian View Of The Market Right Now…
Right now, investors are like a mule deer making its way up to a pond for a drink of water. Cautious as they approach the pond, taking slow and deliberate steps. And then they get a whiff of human scent… Head shoots up, eyes are locked, ears perked. The deer stands there frozen in place waiting to see what comes next. Nine times out of 10 the weary deer bolts and heads for safety.
That’s the sentiment I get from many investors at the moment. There are too many variables that could go wrong and send the market into a tailspin… surging Covid-19 cases, high unemployment, consumer spending, contracting GDP, the contentious presidential election, protests, tensions with China still lurking in the background… and yet, stock prices are hitting new all-time highs.
The laundry list surrounding the negative sentiment is long, no doubt. And there’s plenty of folks who will use the old Wall Street adage that stocks climb a wall of worry to help explain today’s market environment.
But I’m not here to talk about all the negatives. They are gossiped about plenty in the media, we all know what they are, and I can’t say for certain which (if any) will cause the next market crash. No one can.
Instead, let’s take the opposite side and talk about why stocks could climb even higher from here…
The Big Picture
There’s no doubt that the Federal Reserve is doing everything in its power to keep the economy (and market) from crumbling.
At the beginning of the current health crisis, the Federal Reserve slashed interest rates to near-zero (more on interest rates in a moment). The central bank also injected $4 trillion into the global financial system to soften the blow from the pandemic. It bought up investment-grade bonds, junk bonds, and mortgage-backed securities.
We don’t have to go too far back to see what happens to the market when the Fed injects this sort of “stimulus” into the economy. Back in 2008, the Fed used these same tactics to help pull us out of the Financial Crisis. Except back then, it was more commonly referred to as quantitative easing, or QE1, QE2, QE3. And now we have QE4.
Of course, we now know that the stimulus program helped launch one of the longest — and strongest — bull markets in history.
Will this new bull market be of equal length and strength? Only time will tell. But if we learned anything from the last round it’s that you don’t want to fight the Fed. Stocks can climb much higher than we can imagine.
One other thing to note is that when stocks were climbing back to previous highs in 2010, 2011, and 2012, investors held a similar sentiment… Weary of the next big collapse in stocks. They were gripped with fear that a bear market was imminent.
Folks in this boat — too afraid to invest — missed out on some massive gains and investment opportunities. Don’t let that happen to you this time around.
It’s All About Interest Rates…
I still hear it to this very day… “what happens when the housing market collapses…”
The pain suffered from the Financial Crisis is still fresh in many people’s minds… Especially, when it comes to the housing market.
But, again, the Fed cut interest rates to near-zero (low-interest rates benefit companies). And mortgage rates are at the lowest levels… ever (which benefits the housing market). Earlier this week I was chatting with one of my colleagues and I sent him this photo showing rates from my local credit union:
That’s right, you can borrow money for 30 years to purchase a house at a meager 2.6% interest rate. That’s nearly-free money.
I know in a lot of areas around the country the housing market has been on fire. In my neighborhood, houses fly off the market. Just last week the house two down from mine popped up for sale. It had more than 20 showings on the first day it came on the market. It sold in two days for $30,000 over asking.
These sorts of stories are reminiscent of the pre-housing crisis, which is a cause of concern for most folks. But keep in mind, that low interest rates support higher home prices.
Hear me out…
When you shop for a house the sticker price is secondary to the monthly payment. You know what you can afford monthly for a mortgage, and then that determines the price range of houses you can buy.
Today, with historically low interest rates, you can go out and buy a $500,000 home and your monthly payments would only be $2,000 a month (excluding property taxes and insurance).
Now imagine if it was the early 1980s. Interest rates back then averaged nearly 15%. That same $500,000 house would now run you more than $6,300 in monthly mortgage payments. Even in the 90s when mortgage rates were running just north of 7%, it would cost you more than $3,600 a month in payments.
When it comes to housing, it’s not the price of the home that really matters. It’s the monthly payment. And since low interest rates make home purchases more affordable, buyers are willing to pay more – which encourages sellers to ask for more.
This Applies To Stocks, Too
But on the flip side, low interest rates mean we earn less (read zero) when our money is parked in the bank. Right now, the national average interest rate on savings accounts is a worthless 0.06%. Not even a 10-year Treasury offers investors much at 0.6%.
The average stock in the S&P 500 sports a price-to-earnings (P/E) ratio of 28. Of course this is high by historical standards, but similar to the house example, it’s all relative. If we flip that P/E around we get the “earnings yield.” This shows you how much a company earned per share, and it also allows you to easily compare stocks with bond rates.
The earnings yield — the inverse of the P/E ratio — on the average stock is 3.6% (1/28=3.6). So, you could earn about zero with your money in the bank, or invest in the stock market and generate an average earnings yield of 3.6%.
This tells us that stocks — relative to alternative investments — aren’t terribly expensive right now, thanks to low interest rates.
There’s plenty of reasons for investors to be pessimistic or be concerned about the market. But I just gave you three reasons why we should be optimistic: the Fed is pumping trillions into the economy, it’s slashed interest rates so you can buy a home at rates not seen in our lifetime, and it’s made the stock market a better alternative for your money than a bank account or Treasury Bills.
Remember, for most folks, high prices scare them away. But as my readers know (and academic research proves), buying stocks at new highs can lead to tremendous returns in a quick amount of time.
Bottom line: I think there’s plenty of opportunities out there in the market and with real estate as well. Folks who are bold enough to take advantage of them should do very well.
But here’s my disclaimer… while I’m cautiously optimistic about stocks cruising to new highs, I’m not stuck in that belief. I could most certainly be wrong, and I’m okay with that. If I’m wrong, I’ll simply take my profits, cut my losses, and move on to the next investment opportunity.
Either way, this should remind us to not get stuck in your beliefs about the market or a stock. That can lead to catastrophe — large losses, or watching your gains disappear. Stay nimble. Keep your emotions in check, and stick to your trading rules.
Editor’s Note: I recently found something that could make you a fortune in 2020…
While digging through SEC documents, I found a small item in the filings of a little-known satellite technology company. And the implications are huge…
It turns out this company paid a measly $26 million for a tech startup it bought in 2019. That’s an amazing price, but it’s just a small fraction of what they received for their $26 million. And it could amount to the most lucrative opportunity I’ve come across in years…