Has the stock market reached a plateau? There are at least four reasons to think share prices have gone about as far as they are going to go during this market cycle, according to a checklist compiled by a veteran money manager.
David Merkel, a Maryland-based actuary who writes the highly respected Aleph Blog (alephblog.com), says market tops tend to be marked by certain features that even non-technical investors can spot. Some of the most notable signs of a tired market include:
- A retreat by value investors. That is to say, the people who care most about getting value for their dollars are sitting on the sidelines, holding cash and waiting for better opportunities to emerge.
- A decline in the quality of initial public offerings (IPOs).
- Lots of money flowing to private equity deals in search of better returns.
- High levels of borrowing by corporations, with weak protection for lenders.
All those features are present in today’s market, some to a dramatic degree.
Warren Buffett, for instance, is sitting on nearly US$130-billion in cash, waiting for a buying opportunity. His mountain of cash is testimony to the lack of attractively priced opportunities in the market.
Meanwhile, recent IPOs or attempted IPOs, for businesses such as Uber and WeWork, have fizzled. At the same time, money continues to stampede into private equity deals and companies continue to borrow hand over fist.
In its most recent annual report, the Bank for International Settlements warned of “potential overheating,” particularly in the market for leveraged loans, a type of commercial loan provided by a group of lenders, often to finance corporate acquisitions. By the BIS’s reckoning, the leveraged loan market has now reached US$3-trillion at the same time as “credit standards have been deteriorating.”
All this sounds rather ominous, and so it should. The question is what to do with the information.
Trying to time the market is nearly always a bad idea. People who dive out of stocks may or may not avoid a downturn. They nearly always have a problem getting back into the market at the right point and frequently miss out on the next upswing.
Market timers may also miss gains if an overvalued market becomes even more overvalued. This is what happened during the dot-com boom of the 1990s. It could happen again, Mr. Merkel notes, because not all the signals in today’s economy are bearish. Some are downright positive.
Companies are continuing to increase their dividends. The Federal Reserve and other central banks are doing their best to ease monetary policy and help support share values. Unemployment in the United States and Canada remains at multidecade lows. Given all that, a market fall could still be a long ways off.
In his own case, Mr. Merkel is using the current situation as an opportunity to slowly ratchet down risk. He plans to reduce the stock portion of his portfolio from its current 70 per cent to around 55 per cent – the lowest it has been in two decades. But “I’m not running to do this,” he acknowledges.
He is not the only person to be wrestling with the question of what to do in a market where stocks appear fully valued, but the alternatives aren’t noticeably more attractive.
So long as many stocks continue to pay dividends that are substantially higher than bond yields, and so long as a recession doesn’t appear imminent, it’s difficult to see why investors would want to stampede out of stocks. However, it’s also difficult to see much to get excited about. Judged by many common measures of value, share prices in Canada and the United States are already somewhat expensive, by historical standards.
Many investors have their hopes pinned on more cuts to interest rates, or a U.S.-China trade deal, as potential catalysts for higher stock prices. However, Simona Gambarini, markets economist at Capital Economics in London, says bulls are likely to be disappointed. She cautions that today’s stock prices are already assuming that both lower rates and a minor trade deal will come to pass.
“The upshot is that we expect global equities to make little to no headway between now and end-2021,” she wrote in a report this week.
Two years of ho-hum markets aren’t exactly a thrilling prospect for investors (or for investment writers). Maybe the best strategy is to emulate Mr. Merkel and view the current situation as an opportunity to calibrate your risk to whatever level you consider appropriate. At the very least, that will position you to take advantage when stocks are finally ready to make a move.
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