If It Looks Like A Duck

Market Volatility:   Most recent comments can be found here.

Bull/Bear Eye Test

We are currently in a bull market.  Bull markets by definition make a series of higher highs and higher lows.  Thus, if we believe the bull market is still intact, at some point in the future, stocks will make a new all-time high.  

ECONOMIC FEAR

If someone told you the economy was headed for a significant recession and the Fed would most likely be lowering interest rates, would you prefer to own growth-oriented stocks or defensive bonds?  When investors are concerned about future economic and market outcomes, the desire to own bonds tends to be greater than the desire to own stocks.

YELLOW FLAGS BEFORE STOCKS PEAKED

The chart below shows the performance of stocks (SPY) relative to long-term Treasury bonds (TLT).   Early adopters, who saw problems before the financial crisis, started to gravitate toward bonds three months before the S&P 500 peaked in October 2007.  Between July and September 2007, the stock/bond ratio shifted from a full-bore bullish look, favoring stocks, to a full-bore bearish look, favoring bonds.  This observable shift in asset class behavior said "pay closer attention".

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WHAT CAN WE LEARN IN 2018?

The stock/bond ratio in 2018 does not really exhibit any of the concerning characteristics that were present in mid-to-late 2007.   The chart still has a full-bore bullish look favoring growth-oriented stocks over defensive-oriented bonds.   After consolidating in an indecisive manner for several months (orange box), the ratio broke out in a bullish manner in September 2017.  A successful retest of the breakout occurred in November. 

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BULL/BEAR ODDS

This week's video looks at the recent pullback in the context of history.  The charts help us answer the most relevant question - does 2018 look like a bull market or the early stages of significant and protracted decline?

"The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd."
Warren Buffett

WHY ARE BOND YIELDS RISING?

When market participants were concerned about the economy and markets in 2007, they started buying bonds.  Today, we have bonds selling off based on increasing confidence in future economic outcomes.   An improving economy does not fit the traditional early-stage bear market script.  Does it look like a bull market or a bear market?

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Demographics Playing Big Role In Markets

Power Of The Millennials

Markets ultimately price all assets based on the simple law of supply and demand.  Demographics play a large role on the demand side of the equation.  From The Wall Street Journal: 

The U.S. homeownership rate rose in 2017 for the first time in 13 years, driven by young buyers who overcame rising prices, tight supply and strict lending conditions to purchase their first homes.

This time, what’s driving the market is a shift in favor of owning rather than renting coming from the largest homebuying generation since the baby boomers: millennials.

“There’s no government incentive program in sight that is having this effect,” said Susan Wachter, a professor of real estate and finance at the Wharton School at the University of Pennsylvania. “This is back to basics.”

Stocks, Baby Boomers, and Millennials

The baby boomers were 22-29 years old when a secular trend began in the stock market in 1982; the trend lasted 18 years.  In 2017, the millennials were 13-35 years old.  The demographics and chart patterns shown below tell us to keep an open mind about better than expected outcomes in the stock market over the next 5 to 20 years.

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These concepts were covered in detail in a September 1, 2017 video.  Since publishing the video, stocks and housing have both appreciated.