Traverse City Record-Eagle

Business

February 9, 2014

Jason Tank: Taking stock a prudent first step

TRAVERSE CITY — With stock markets acting jittery and volatile after a prolonged period of calm, it is not too late to officially take stock of your exposure to stocks.

Most investors are prone to bask in the glory of their rising year-end account balance and postpone any adjustments for another day. And, typically, that day never arrives. As a result, they unnecessarily subject themselves to market downturns. To prod you into action, let me paint a picture of why you should review your investments soon.

Since late 2011 through the end of last year, the stock market as measured by the S&P 500 has delivered a return of about 75 percent. During this stretch, the market had not at any point dipped by much more than 10 percent. In fact, throughout this unusually calm period, the declines actually grew smaller and smaller. The market culminated its astounding run last year with a whopping 32 percent return. All of this fed a palpable sense of confidence and complacency toward investment risk. After five years of economic and financial market recovery, investors’ memories have predictably grown short.

The crescendo rally of 2013 occurred despite the fact that US economic growth never really accelerated beyond its meager pace of about 2 percent. Added to this, corporations continued to deliver somewhat tepid and, most importantly, decelerating sales and earnings growth. These are not the normal ingredients for such a rapidly rising stock market. Even with the recent market decline — still quite small — the stock market appears to have already fully-baked the long-hoped for acceleration in economic growth in the cake.

Famed investor Warren Buffett once remarked about the high cost investors pay for a rosy consensus. At today’s levels, many reputable and long-term measurements of investment value are flashing warning signs for investors.

For example, one well-known metric used to value the stock market, the Shiller Cyclically-Adjusted Price-to-Earnings Ratio, has a particularly strong record for predicting the general level of returns investors should expect to earn in the decade ahead. This measure works to value the stock market, not against short-sighted data such as last year’s or even next year’s expected earnings, but instead against a longer-range history of company profits. This longer-range history is designed to include both economic expansions as well as recessions. As its name suggests, it rightfully acknowledges the cyclical nature of things.

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