By Maurice Stouse, Financial Advisor and Branch Manager
We often get the question or the comment regarding a market correction or worse, a bear market. We also take note that, historically, many corrections have been made in September and October. Why that is so is the subject of speculation. Most folks are focused on now vs. the past of course and with the market having rallied for over a year now and multiples at historical highs, people are beginning to wonder.
While market corrections can happen at any time, we would even suggest that by the end of the day this article is being written, a correction could take place. Investors, understandably so, want to know if a market selloff is about to happen. The problem, at least in our experience, is that they don’t ring a bell at the top, signaling people to get out and they don’t ring a bell at the bottom signaling for people to get back in.
We feel investors should pay close attention to key drivers in asset valuations:
First, The Federal Reserve balance sheet. It has more than doubled in the past year and a half and is up tenfold since 2008. The current amount is $8.357 trillion as of September 8th (see federalreserve.gov/monetarypolicy).
The Fed’s balance sheet is made up on the asset side of Treasuries and mortgage type securities that it has purchased on the open market. The more The Fed buys, the more money or monetary stimulus, is released into the U.S. financial system. Where does The Fed get the funds for those purchases? Typically, it is through creating or “printing” more money. There are several factors that drive asset prices, and we feel that in this environment, the key driver is the growth of the balance sheet. So, as investors’ worry grows over market corrections, keeping an eye on the balance sheet is a good indication of the amount of liquidity that exists in the financial system. The greater the liquidity, the greater the support for asset prices. If liquidity is withdrawn (through tapering as an example) that, in theory, means less stimulus and potentially less liquidity. That might mean asset prices could become more volatile.
Second is the yields on the benchmark U.S. Treasury as another significant factor that drives markets and or adds to or lessens volatility. We suggest that our clients pay most attention to the yield on the 10-year U.S. Treasury bond. Why? That is what most professional investors and market followers focus on. The yield right now is approximately 1.35%. Note the yield on the S&P 500 is very close to that. So, if the yield climbs significantly, we think (from what we have researched and concluded) to approximately double the yield of the S&P 500, that in and of itself would be a trigger or drag on stock prices.
Third, we continue to be wary of bonds and the implications yields can have on them and potentially the stock market. Should clients desire to invest in that area, we express caution as we feel that climbing yields (because of inflation, an increase in the supply of Treasuries for sale as examples) would continue to put pressure on investment grade bond prices. Inflation’s most recent reading is 5.3% year over year (it was 5.4% when reported last month). We would suggest investors consider high yield bonds or floating rate bonds in an economic environment such as this. While those carry greater quality risk, they might fare better than their investment grade counterparts.
Finally, and always, at The First Wealth Management, we encourage our clients to 1) concentrate to accumulate and then diversify to preserve 2) to monitor and make changes to their strategies over time vs overnight 3) consider the impacts that taxes can have on their savings and investments.
The First Wealth Management is located at First Florida Bank, a division of the First, A National Banking Association, 2000 98 Palms Blvd, Destin, FL 32541. Branch offices are located in Niceville, Mary Esther, Miramar Beach, Freeport and Panama City. Phone 850.654.8124.
Raymond James advisors do not offer tax advice. Please see your tax professionals. Email: Maurice.stouse@raymondjames.com. Securities offered through Raymond James Financial Services, Inc. Member FINRA/SIPC, and are not insured by bank insurance, the FDIC, or any other government agency, are not deposits or obligations of the bank, are not guaranteed by the bank, and are subject to risks, including the possible loss of principal. Investment Advisory Services are offered through Raymond James Financial Services Advisors, Inc.
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