Dow Jones Stock Market Today – What’s Next For The Stock Market? A Financial Planner Breaks Things Down
The stock market has had a roller coaster year since the coronavirus pandemic hit, notching record highs as well as a significant correction. With the Dow Jones Industrial Average now hovering above 31,000 and Congress poised to goose the economy with another major coronavirus relief package and vaccines promising to allow Americans to begin returning to normal, it appears poised to surge higher.
The climate poses opportunities for small investors as well as pitfalls that could wipe out retirement savings. Certified financial planner John Bever says the current market reminds him of the irrational exuberance of the 1990s, but there are things small investors can do to protect themselves.
IBT: What is the stock market doing and how can the small investor protect retirement savings?
Bever: The stock market is doing what it always does: It discounts future earnings and compares that to the risk-free rate of return. Right now, the market is struggling a little because Treasury rates are pushing the upper envelope. If rates hit 1.5%, you will see a pullback in stocks.
Small investors have to be sure they’re not risking capital they can’t afford to lose if buying individual companies. The biggest thing is to properly assess risk. That’s a hard thing to do, and the individual investor may not have the tools.
Funds are in a better position to make those risk assessments and should be at the core of an individual investment strategy. Then the investor can dabble around the edges with individual companies. That’s both entertaining and educational. Small investors should view individual stocks as supplemental retirement income – fun money. If they lose that, they’re not going to jeopardize their retirement.
IBT: What is the smartest move the small investor can make in this climate?
Bever: You can’t go wrong with a monthly investment plan. If you have a 401(k), you’re already doing that. Dollar-cost averaging – dividing up the total being invested across periodic purchases of a target asset to reduce volatility – should be aggressive. If the market goes down, the monthly investment will buy more shares. You can always sit on the sidelines to lower risk. Put monthly additions into equity funds.
The best opportunities are in small caps and emerging markets. Small companies have the ability to be more nimble and have exponential growth. Mega cap companies can’t grow as fast as in the past.
IBT: What are some of the pitfalls facing small investors?
Bever: The biggest pitfall is the plethora of information. Small investors risk information overload.
The second is market valuation: The market is priced for 1% Treasury yields. It’s hard to find an analyst who will say we will stay at 1% for the next 10 years. We’re likely moving to the inflationary part of the cycle. There’s no good answer on when 4% yields will kick in. The question is how to manage risk in a rising rate environment.
Bonds will always be part of a portfolio. We’re taking a barbell approach – investing in long- and short-term bonds, but not intermediate-term. This allows the short-term investments to roll over into higher yield investments as interest rates rise.
IBT: What impact will the moves toward sustainability mean for the small investor?
Bever: The impact is indirect, but fund portfolios are going to concentrate more and more on these issues. That’s actually turning into a winning strategy for now, but it’s hard to say if that will be a winning strategy over the next decade.
Proper governance is the key and in the long term, it’s a good strategy to emphasize. It keeps a company from getting sloppy. All we have to do is look back at the Enron days. (Note: Enron went bankrupt in 2001 and took the auditing firm Arthur Andersen LLP with it. The company lost $74 billion in four years amid accounting and corporate fraud.)
IBT: What’s the best piece of advice for investors?
Bever: Investors should be aware of two emotions: fear and greed. Don’t let fear and greed drive you. Don’t get scared out of the market. Don’t get greedy. Just because you did well in picking a few stocks, don’t let a false sense of security take over. On the fear side, if you’re balancing risk right and can identify acceptable losses, you won’t run the risk of a big blow-up that has you walking away from the table. That would be a mistake.
Think about the investors in the 1970s who said they were never investing in stocks again. Since the 1970s, several things have happened. First thing is we’ve been in this long-term downturn in interest rates. They’ve been trending downward since 1982. The lower they go, the higher the P/E ratio. That affects company valuations.
Second, tech has created efficiencies and increased productivity.
The third thing is the concentration in mega-caps. They’re just dominating. The last time we had a period like this was the 1960s – the nifty 50. If you owned the top 50 stocks, you did just fine. The tone changed in 1965. It didn’t work so well anymore.
When coming off a financial crisis, the largest companies dominate. Since 2008, that’s been the case. We can’t predict when they won’t have the largest returns. But as we get into the inflationary side of the cycle, that tends to hurt the larger companies.
With indexing taking place, it’s a self-fulfilling prophecy. The portfolio reflects the S&P, which is dominated by the top 50 companies. It becomes a larger piece of the pie as more investors go that route, creating a bigger bubble and the extreme valuations we have right now. The P/E ratio is at 34. That’s unsustainable. It should be 25. The way you correct is either decline or grow earnings.
IBT: Where does the Federal Reserve fit in all this?
Bever: The Fed is still being very accommodative. It would have been unthinkable in the 1980s for the Fed to engage in quantitative easing, and we’ve seen big use of that. It started with the failure in 1998 of the hedge fund Long Term Capital Management, which had attracted investments from banks and other high-end investors. It was a huge success – until it wasn’t. When that strategy failed, the Fed stepped in to bail out the banks. It was a mistake, but it set the tone for the Fed going forward. The result was to encourage more risk, creating the same moral hazard and leading to the 2008 financial crisis.
What’s going to happen in the next bond crisis? The Fed likely will step in again when the solution should come from the market. It’s not good policy to have the central bank that involved, but that’s the environment we have. It has created a more bloated stock market. And now we have an environment where investors expect the government to bail them out.
The Fed is focused on creating full employment and stability in the stock market. That’s become the unwritten mandate. There’s no way out of it because the pain would be too great.
But that’s modern monetary theory, and it’s been accepted.
IBT: What we can we expect from the economy?
Bever: The economy is ready to run. People are ready to get past COVID. Science progression has been amazing and there’s more coming on the vaccine front. The market is getting more democratized. That’s a good thing.
The biggest issue is the $28 trillion debt versus $21 trillion in gross domestic product. Servicing that debt is going to get more and more challenging. It will continue to grow faster than GDP and eventually there will be a financial day of reckoning.
John Bever is president of Phase 3 Advisory Services of Buffalo Grove, Illinois. He is a certified financial planner with 30 years of experience. Bever attended Moody Bible Institute, Chicago, majoring in communications and received his BS in organizational communications with additional studies in business and personal finance from Southern Illinois University, followed by additional studies through the College for Financial Planning.
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