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Is this a Bubble?

[A SPECIAL R&D REPORT FOR THE ME-P]

By David K. Luke MIM, MS-PFP, CMP™ [Certified Medical Planner™] http://www.networthadvice.com

David K. LukeThe market news has been replete with the phrase “new market high“ in the business news every couple of weeks as of late. The corresponding message is often that the stock market is likewise in a bubble. The S&P 500 index and the Dow Jones Industrial Average index are at all-time highs. The indexes have surpassed the 2007 peak.

The reality is however that the S&P 500 is up less than 6% from the beginning of the year, and the Dow is up about 2%. Most investors, of course, do not invest just in these two indexes, as these two indexes represent very large capitalized companies.

I am reminded of the customer in 1995 when I worked at a national brokerage firm that called me to liquidate his entire stock portfolio. “The stock market was too high,” he said. He was 5 years too early.

Risk Mitigation

Most investors will have a diversified portfolio that includes mid-cap stocks, small-cap stocks, and international stocks as well as large cap stocks such as found in the S&P 500.

Of course, these equity investments are also typically subdivided into the broader categories of “Growth” and “Value.” Which means most investors that believe in diversification will own four different “types” of stock, each divided into two different categories for eight different baskets of stock if you will. The typical daily news will focus only perhaps on the S&P 500, which is a portfolio of large capitalized growth stocks. This is only one of the eight different types of stock that an investor would typically own.

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In strong bull markets, typically all eight categories of stock go up together with some degree of correlation. This is also true in strong bear markets with all eight categories of stock going down in some degree of correlation. Portfolio managers typically try to offset high correlation of investments by owning investments in asset classes that typically do not all correlate together. This is a major technique used to reduce the volatility in an account.

However as you can see so far this year, most all of the eight stock indexes with the exception of small-cap growth are up slightly in line with the S&P index.

***

[As of June 13, 2014] 

Name Ticker % Total Return YTD % Total Return 12 Month
Large Cap iShares S&P 500 Growth IVW 5.59 22.55
iShares S&P 500 Value IVE 5.76 18.39
Mid Cap iShares S&P MidCap 400 Growth IJK 2.69 18.24
iShares S&P Mid-Cap 400 Value IJJ 7.66 23.19
Small Cap iShares S&P Small-Cap 600 Growth IJT -0.52 20.8
iShares S&P Small-Cap 600 Value IJS 2.3 21.37
Foreign Large Blend iShares Core MSCI EAFE IEFA 3.75 19.25
Barclays Aggregate Bond Index iShares Core US Aggregate Bond AGG 3.26 2.39

Source: Morningstar

***

Inflation

The buying power of the US Dollar has changed over the years. The Consumer Price Index (CPI), a common measure of inflation, has averaged around a 3% annual increase from 1913 – 2014 according to the U.S. Department of Labor Bureau of Labor Statistics.

In fact, an item purchased for $5.00 in 1913 would have a cost of $119.73 today, or a cumulative rate of inflation for the past 100 years of 2,294.7%. The cost of living rising each year is a safe bet. Inflation has increased every year in the past 50 years with one exception: 2009 when inflation fell -0.4%.

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Update: 06/17/2014 04:10 ET

[Market Update]
Symbol Last Change
DOW 16,808.49 +27.48
NASDAQ 4,337.23 +16.13
S&P 1,941.99 +4.21

Conclusions:

  1. The Market Indexes at new highs does not indicate a bubble. In fact, the market should, relatively speaking, regularly be hitting new highs because of the consistency of positive inflation. Prices of goods and services today are at all-time highs. Does that mean we are in an “inflation” bubble? No. This is normal.
  2. The S&P 500 is not an accurate measure of the US economy. While the S&P 500 is the common “market” indicator in the US, only about 55% of the earnings of the index come from the US. (Source: RBC Capital Markets Research, Capital IQ 2012). This is because mainly large multinational companies such as Google, IBM, and Apple that have a significant amount of overseas revenues weight the index.
  3. The S&P 500 or the Dow Jones Industrial Average (DJIA – 30 stocks) is most likely not an exact reflection of your personal stock portfolio, which would expectantly be more diversified. A typical well-diversified long-term investment portfolio would include not just large cap stocks (such as found in the S&P 500 or DJIA), but mid, small, and international stocks from the growth and value camp, as well as a diversified bond holding.
  4. Overpriced stocks, just like overpriced real estate, are more prudently ascertained by value measures, not simply by raw index numbers. A stock hitting new highs could still be quite undervalued. Meaningful variables such as earnings growth, price to earnings ratio, dividend yield, price-to-book, price-to-sales, and other metrics should be considered.

Conclusion

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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15 Responses

  1. New Market Highs

    Yep, US stocks rose today, sending the Standard & Poor’s 500 Index to an all-time high, as the Federal Reserve said growth is bouncing back and repeated that interest rates will remain low for a “considerable time.”

    The S&P 500 rose 0.8 percent to a record 1,956.98 at 4 p.m. in New York, gaining for a fourth straight day. The Nasdaq Composite Index jumped 0.6 percent to the highest closing level since 2000.

    Dr. Zirah

    Like

  2. Another Record

    Dr. Zirah – US stocks rose again today, sending the Dow Jones Industrial Average to a record, as drugmakers rallied on merger activity and investors speculated economic growth will accelerate.

    And, health care companies in the Standard & Poor’s 500 Index jumped 0.8 percent to help lead the advance amid a takeover offer for Shire Plc.

    Bud

    Like

  3. More Highs

    DOW 16,956.07 +129.47
    NASDAQ 4,458.65 +50.47
    S&P 1,973.32 +13.09

    Mike

    Like

  4. Yet, again!

    DOW 16,976.24 +20.17
    NASDAQ 4,457.73 -0.92
    S&P 1,974.62 +1.30

    Mike

    Like

  5. Passing 17,000

    DOW 17,068.26 +92.02
    NASDAQ 4,485.93 +28.19
    S&P 1,985.44 +10.82

    Mike

    Like

  6. Why the Dow at 17,000 matters

    You might think big round numbers are meaningless, but plenty of experts say they actually can influence the stock market.

    http://money.msn.com/top-stocks/post–why-the-dow-at-17000-matters

    Richard

    Like

  7. BEAR or BULL?

    Three reasons the Dow shouldn’t be at 17,000

    This has to be the most unenthusiastic rally in a generation. Here’s why the gain feels empty.

    http://money.msn.com/top-stocks/post–3-reasons-the-dow-shouldnt-be-at-17000

    Is Dow 18,000 now on the horizon?

    Wharton School professor Jeremy Siegel says he could see the average hitting another big number by the end of the year.

    http://money.msn.com/top-stocks/post–is-dow-18000-now-on-the-horizon

    Dr. Mecham

    Like

  8. Update: 07/14/2014 05:17 ET

    DOW 17,055.42 +111.61
    NASDAQ 4,440.42 +24.93
    S&P 1,977.10 +9.53

    Mike

    Like

  9. Why Average Investors Fail to Keep Up with the Markets

    A Market in Dis-Array

    http://www.msn.com/en-us/money/markets/a-market-in-disarray-awaits-the-next-move/ar-BB8wksM

    ***

    The failure of the average investor to keep up with investment markets (or even inflation, for that matter); is usually due to market timing and emotionally driven decisions to move into and out of the markets.

    How long has it supposedly been common knowledge we are better off choosing an investment strategy that represents risk tolerance, and sticking to it both in the good times and bad?

    Still, most investors are terrible at sticking to their strategy when markets stall, and still have an overwhelming urge to buy after the market has already done well, and then sell shortly after a market drop (i.e. buy high and sell low).

    This is where having a written Investment Policy Statement [IPS] can be invaluable.

    Additionally, working with a fiduciary financial advisor with a history of executing a steady, buy-and-hold approach can provide important support in avoiding detrimental behaviors during the rough times [personal communication, Lon Jefferies; MBA, CFP®].

    Dr. David Edward Marcinko MBA CMP™
    http://www.CertifiedMedicalPlanner.org
    http://www.amazon.com/Comprehensive-Financial-Planning-Strategies-Advisors/dp/1482240289/ref=sr_1_1?s=books&ie=UTF8&qid=1407584271&sr=1-1&keywords=david+marcinko

    Like

  10. U.S. Stocks Extend All-Time High With Fifth Day of Gains

    U.S. stocks were little changed, with benchmark indexes extending all-time highs, as gains in homebuilder shares helped offset losses among industrial companies.

    http://www.msn.com/en-us/money/inside-the-ticker/us-stocks-extend-all-time-high-with-fifth-day-of-gains/ar-AA7Aqir

    Tom

    Like

  11. Another Market High

    Ethan – 17,810.06 – The 45th new high this year … sigh!

    Naomi

    Like

  12. Why 18,000 Matters

    Yep – US markets continue to soar. The Dow Jones Industrial Average topped 18,000 for the first time in history, propelled by the latest news about GDP growth.

    http://wealthmanagement.com/blog/daily-brief-crashing-financial-party-its-1999?YM_RID=CPG09000002702210&YM_MID=1514&NL=WM-27&Issue=WM-27_20141224_WM-27_61&sfvc4enews=42&cl=article_6_1&elq=56b346e31c294e5b9c1fd3d2b8674155&elqCampaignId=1225#stocks

    If you’re looking for a quick and easy way to explain to your family why this record actually matters, Vox put together an excellent primer for the layperson.

    http://www.msn.com/en-us/money/markets/dow-18000-have-stocks-come-too-far-too-fast/ar-BBhb8E9?ocid=iehp

    Ethan

    Like

  13. The Q ratio?

    The concept is embodied in a measure known as the Q ratio developed by James Tobin, a Nobel Prize-winning economist at Yale University who died in 2002.

    http://www.amazon.com/Comprehensive-Financial-Planning-Strategies-Advisors/dp/1482240289/ref=sr_1_1?ie=UTF8&qid=1418580820&sr=8-1&keywords=david+marcinko

    According to Tobin’s Q, equities in the U.S. are valued about 10 percent above the cost of replacing their underlying assets — higher than any time other than the Internet bubble and the 1929 peak.

    http://www.msn.com/en-us/money/inside-the-ticker/nobel-winners-math-shows-stocks-are-unhinged-from-reality/ar-BBjU75y?ocid=iehp

    Harold

    Like

  14. A reminder from European stocks about diversification
    [A Mid-Year 2017 Update]

    After underperforming U.S. stocks in recent years, European stocks have outperformed recently.

    For example, the FTSE Developed Europe All Cap Index was up more than 16% from the beginning of the year through June 23. This rise is despite significant political and economic headwinds during the period, including the United Kingdom entering negotiations to exit the European Union and continuing weakness in the European banking sector. That figure was well ahead of the roughly 9.6% increase for U.S. stocks over the same period, as measured by the CRSP US Total Market Index.

    The shift in performance leadership underscores how hard it is to predict market movements, a warning for those who might be tempted to place bets on how certain countries or regions will perform in the short term. At the same time, it also hints at the potential diversification benefit that global investing offers.

    Physicians and Lay-Investors who choose to stay close to home, investing in a broad mix of U.S. stocks and bonds, may feel their portfolios are already diversified.

    The bigger picture, though, is that they’re missing out on almost half of the world’s stock market capitalization and an even bigger slice of the global bond market. Broad exposure to international securities over the long haul can help reduce a portfolio’s volatility by mitigating losses when domestic stocks do poorly. Such exposure can also add to returns when international markets shine—as Europe has done so far this year.

    What’s the optimal amount of international exposure?

    It depends on the investor, but research has shown that adding even a modest allocation to international securities can help reduce portfolio volatility.

    As Vanguard Chairman and CEO Bill McNabb advised in a recent blog post, “Own the whole haystack and you never have to worry about finding the needle.”

    Dr. David Marcinko MBA

    Like

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