At least five adverse factors are now discounted by the stock market. What could go wrong?
It appears that the stock market has discounted already the following:
- No rate hikes in 2019
- No full yield curve inversion
- Trade talks with China are successful
- Earnings growth is maintained
- Debt (high deficits) is not a problem (MMT)
The stock market has taken an overly optimistic stand with above very complex issues. It is true that optimism has paid off in the past and most portfolio managers are optimistic by nature. However, we cannot know if optimism at this point is due to wishful thinking; after all, positions, salaries and bonuses depend on market performance.
What could go wrong? Maybe all of the above could go wrong or any combination of them. Or maybe some unknown unknowns. Maybe the market can absorb only one or two of the adverse factors but not three, four or five going against it.
There are always negative factors working against it and often the market manages to navigate through the storm with help of central banks and stubborn investors who believe in a longer-term upward bias. But the combination of possible adverse factors at this point is daunting.
Younger investors can probably survive another 50% drop such as those that have already occurred twice in the last 18 years but investors near retirement will probably panic after about a 30% decline and take the loss to preserve capital. As far as diversification, it is a questionable strategy at this point. The standard 60/40 diversification had a drawdown of about 30% in 2009.
If both stocks and bonds go down next, the losses can get worse. Over-optimism may be a trap. Therefore, investors should look for a competent registered adviser who understands the risks. Because in our opinion, investing in the stock market at these levels without proper and robust diversification is a fool’s errand.
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