Is the Market Too High? What should I do?

| February 15, 2018
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Investors have really enjoyed the market gains of the last 15 months, but the recent market volatility is also providing anxiety for some valid and obvious reasons. Below are a few common questions we’re getting…

Is the Market Too High?

While it may feel like there is no justification for why the market has gone up the way it has, there are three very valid fundamental reasons that have added fuel to the market’s rise.

  • Corporate earnings are very strong.
  • The recent tax cuts have added to the potential for even greater corporate profitability.
  • Global economic growth is solid.

However, we do see indications that the market might be slightly overvalued based on two of our favorite valuation indicators.

  • According to a JP Morgan piece called “Guide to the Markets 1Q 2018”, the S&P 500 is currently trading at a P/E ratio that is about 15% higher than the 25-year average
  • Morningstar’s “Market Fair Value” ratio indicates that stocks are about 5% overvalued.

Overseas, the situation is quite different, with the P/E ratio on the ACWI ex-US index currently below its 20-year average.

In summary, we think the US market might be a bit overvalued, but we’re encouraged by strong earnings growth and more attractive valuations overseas.

Is a Downturn Coming?

Market downturns are inevitable, and they’re also impossible to predict with accuracy. History suggests that market declines of 10% or more are quite common, and while they can be painful they’re also part of a normal and healthy market. One thing to keep in mind, a 10% drop equates to about a 2,500-point decline on the Dow Jones Industrial Average. That sounds like a really large drop, but it’s quite normal and we think it’s prudent to be emotionally prepared to endure large point declines like this.

What Should I Do (and NOT Do) Now, and What Should I Do When the Market Declines?

We work hard to create diversified investment plans that provide an acceptable balance between risks and opportunities. We also know that in market conditions like this, investors are often tempted to dramatically alter their investment portfolios. We think the points below offer some common-sense ideas for investors to consider.

What to do now?

  • Reward yourself…. Realize some gains, set aside some cash and pre-fund that vacation you’re planning for next summer or buy that car you’ve been waiting to purchase.
  • Charitably inclined? Donate appreciated assets to your favorite charity or set aside assets in a donor advised fund. Gifts are at a discount today when you consider similar assets donated a year ago would have been less valuable.
  • Keep your future withdrawal expectations reasonable. Be conscience of and try to reduce the urge to increase your annual distribution amounts due to the inflated portfolio value.
  • Re-balance portfolio – We do this automatically on a regular basis for the portfolios we manage… selling some of the gainers and re-allocating to other areas of the portfolio.
  • Keep on your investment plan! You’re here for the long-term. Don’t let your emotions get in the way of being a successful investor.

What not to do now?

  • Don’t attempt to time the market and liquidate large portions of an investment portfolio.
  • People tend to lose more by missing out on the upside than they save protecting on the downside.
  • Selling stocks and leaving it in cash doesn’t usually eliminate stress. Rather, it just shifts the stress to deciding when to buy back in.
  • Cash has a terrible track record as an investment. Owning $1 today can’t be exchanged for a greater amount of cash in the future.

What to do when the market declines?

  • Tax Loss Harvesting – capture losses within taxable accounts and use them to offset future gains
  • Roth Conversions – converting an IRA (or a portion) results in less taxable income when the valuations are lower
  • Invest extra cash while the market is on sale – when the market is down, it’s time to invest!
  • Postpone discretionary expenses – when the market is at highs it’s time to pre-pay expenses, when it isn’t doing as well, the inverse is the more reasonable action.
  • Keep withdrawal rates reasonable – a 4% withdrawal rate at all-time highs might be the equivalent of a 5% withdrawal rate after the market has taken a dip.
  • Rebalance portfolio – As mentioned above, we do this automatically on a regular basis for the portfolios we manage.
  • Don’t Panic! Don’t let your emotions get in the way of being a successful investor.

We know this topic is important to many investors, and we think it deserves a significant amount of discussion. To that end, we invite you to attend a webinar that will take a deeper dive into the topics above. If you’re interested in attending one of these webinars, please respond to this email and we will put you on the list to be notified when they’re scheduled.

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