Market Valuation, Stock Prices, and the FutureSubmitted by Bernhardt Wealth Management on February 24th, 2020
In a November 25, 2019 interview, Jeremy Siegel, the Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania, offered this perspective on the equity markets: “I'd say we're at fair market value now.” He went on to list a number of factors, including historically low interest rates and low inflation, persuading him that stocks are still fairly valued. Remember that at that time, the Dow Jones Industrial Average (DJIA) was at nearly 28,000 and the S&P 500 Index registered just over 3,100. At this writing, the DJIA is at almost 29,000 and the S&P 500 stands at just over 3,300.
On the other hand, the equity markets declined sharply from new highs in recent days on news of a new South Korean outbreak of COVID-19 (formerly coronavirus). Previously the markets had rallied just as sharply on reports of a slowing in the rate of new cases in China. Clearly, any news that creates uncertainty around world economic health—and physiological health, in this case—has great potential to create movement in stock prices.
Professor Siegel made a number of other comments and predictions about returns on equity investments over the next several months, about likely interest rate trends, and about the overall health of the economy. He warned of the effects of political disruption that could potentially result from the election of a presidential candidate perceived as anti-business, and he also noted the dangers to the economy of an all-out trade war with China, while indicating that he considered both of these outcomes as unlikely.
What should the average investor do with this information? Is there any value in such predictions?
In answering this question, another line from the interview seems particularly noteworthy. After indicating that 7–8% nominal returns on equities seemed possible for 2020, Siegel said, “Warning: We all know that the standard deviation of one-year returns is about 20%, so a point estimate for one year has a high margin of error.”
In other words, Professor Siegel is underlining what we often remind our clients: making predictions about future stock returns for any given period is an effort containing a high statistical probability of error. Does that mean that all predictions are wrong or wildly inaccurate? Of course not. In fact, Siegel correctly predicted the general movement of equity markets for 2019. But even the most learned economists and analysts, viewing the markets near the end of 2019, could not have predicted the outbreak of a new virus or the effect it would have on the global economy. In fact, we are still waiting to see the exact extent of that effect.
Investors should remember that uncertainty is part and parcel of the equity markets, and no amount of research can remove all risk from any type of asset. But it is also important to remember that investors can control their exposure to those risks, maintaining an asset mix that accurately reflects their tolerance for risk and their most important financial goals. Once that mix is attained, investors will do well to remain patient, allowing the market to continue setting the values for various investments based on all the information known at any given time.
On the other hand, attempting to time the market by selling or buying in response to news headlines will most often prove counterproductive to overall returns in the long term. Research clearly indicates that changing asset allocation or strategy in an attempt to get ahead of tomorrow’s headlines penalizes the investor in an overwhelming majority of cases.
If you have concerns about the current market environment or other questions about investing or financial planning, we invite you to call with your questions and concerns.