How Much Higher Can the Stock Market Go?
This is a question that is being asked a lot these days. The answer could make a big difference to your financial security, especially if you are retired, or within 5 years of retirement.
I think in order to figure out the answer to this question, we have to look at a number of factors.
The First Issue Is “Why Is the Market Going Up”?
After all, the value of a stock is supposed to reflect how well the company is growing and how profitable it is. Since March, we have seen a sharp drop in our economy and then a partial recovery, but nowhere near where the economy was producing back in February.
So why the disconnect? I believe it is the result of a couple of factors.
People say the stock market is forward looking. This means you buy based on what might happen in the next 6-12 months. The old saying on wall street is “Buy the rumor, sell the fact”. So clearly the market is anticipating a fairly quick return to a fully functioning economy.
From When I Started to Today
Decades ago, when I first was investing and then getting my licenses, the general thinking was that when the economy expands or a company becomes more profitable, then stocks will rise.
Today, with all the different ways to participate in the market (High Frequency Traders, Hedge Funds, Index funds, daily asset allocation are a few) many investors and traders are just looking at whether the stocks are moving up and don’t ask why.
This is known as “Momentum Investing”. This type of disconnect has increased volatility a lot over the last 20 years.
So, given that unemployment is high, business activity is off and there have been disruptions in many industries, what is driving prices higher?
What’s Happening to the Stock Market
The likely catalyst has been the Federal Reserve. While congress has allocated Trillions of dollars in aid for the economy, the Federal Reserve has been quietly buying up assets in a way that has never been done before.
Usually, if we have some disruption and deficit spending rises, the Federal Reserve (The Fed) would purchase bonds issued by the treasury to provide the liquidity and financing for that deficit. Back in 2007-2008 this participation expanded, and the Fed purchased mortgage backed securities to help prop up the mortgage market.
There was the TARP, where Treasury lent money to companies and secured those loans with equity in those businesses.
What’s Different Today?
Now the Fed is buying assets they have never bought before. Mostly high-risk assets like high yield corporate bonds (we used to call them “Junk Bonds”) from companies that are on the brink of folding. They have also been buying ETF’s in an effort to prop up stock prices.
Wall Street looks at this and says, “the Fed is buying and won’t let these companies go out of business, so I should invest there as long as they are keeping them afloat, I can’t lose”.
The Federal Reserve has purchased hundreds of billions of dollars in low grade assets which has encouraged more speculation in those assets. This is a circle that is essentially the Fed and stimulus money going to wall street, without regard for the condition of the underlying economic realities.
The other side of this equation is rising long term unemployment, businesses that can’t reopen fully due to rising Covid-19 infections, bankruptcies on the rise and social unrest. Historically any one of these would be enough to knock down the stock market on their own.
How Long Can This Go On?
My answer to the question in the title of this article is, things can go up as long as the Fed keeps propping up unprofitable companies and buying high risk assets.
The answer to the question? I don’t know as we are in uncharted waters.
- My concern is what if the economy does not go back to the conditions that we had back in February for years?
- What if the Fed stops buying this stuff?
- What if the world stops buying our treasury bonds that finance our debt?
- You can come to your own conclusions, but this is a very real concern.
As I told clients who reached out to me back in March, wondering if they should be buying stocks. I told them, “if you are looking for a trade, and will pay attention to when to sell, then it is a great time to buy.
If you are a long term investor, you will probably have the opportunity to buy these assets at lower prices in the coming years. That is when it will be less risky to purchase stocks and other volatile investments.
There is a lot more background to this discussion, if you would like more supporting data or wish to discuss how this might affect your investments, contact us to set up a conversation.
Final Thoughts: A Pro Tip
The other reason to contact us now is to have us help you set up your portfolio so you can profit if the market keeps moving up and setting records, but protect your principal if things go south.
That way, you don’t have to worry about how high the stock market can go because your downside is protected from loss.
Schedule your free one hour virtual consultation now by calling (415) 331-9030.
Roger holds the coveted and well-earned designations of Chartered Financial Consultant (ChFC®) and Retirement Income Certified Professional (RIPC®) from the American College. He is also a licensed insurance agent for life and health insurance and a Certified Paralegal for Estate Planning.