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How High is High?

by Thomas J. McCarrell, CFA, Vice President, Senior Portfolio Manager

 

My Dad called last week. He was inquiring to see if he should get out of the stock market. He had been watching the evening news and had just seen a report about stocks breaking into record high territory. To him, it seemed that getting out might be the smart move. He doesn’t want to live through another steep downturn. His question was incited by a reporter whose logic was along the line of: if the stock index had just hit a new (numerical) high, then the next move has got to be down. Reverting back to my childhood for a moment, I asked him “WHY?” He seemed exasperated and responded, “it’s at an all time high!” I had to admit that he was correct, based on the numerical value of the index, but then the conversation moved toward the valuation of the index based on other factors. Is it at an all time high based on the price of the index versus the earnings of the companies within the index? Is it high based on the growth potential of those companies and the broad economy? Do we perceive that the economy is getting better, or worse? What other investment options have better potential for someone with his time horizon, risk tolerance, and return objectives? This conversation is becoming more and more commonplace as we see the prices of investments rise. The key is to look broadly at all of the factors that move the markets and then consider those factors against your own investment objectives.

 

Our perspective on the economy has not changed. We expect that we will continue to see slow growth in the United States economy, as measured by Gross Domestic Product, and expect that the rate of inflation will run below the historical average. The Federal Reserve has expressed that it will continue to hold interest rates at low levels, in order to encourage growth and reduce unemployment. Consumer sentiment and consumer spending numbers were up in March, reflecting optimism that could strengthen the economy further. Along with the positive incentives for growth, we can’t forget that the economy is far from getting overheated. We have yet to see any significant impact from the Federal spending sequester, new employment numbers are low, and there is still a significant budget debate going on in Congress.  

 

On a positive note, there was good news for the State of Michigan and investors who hold Michigan bonds in March. Moody’s Investors Service increased Michigan’s rating from “stable” to “positive” based on improvement in the State’s fiscal condition. This change will help keep financing costs low for the State and benefits investors by improving the credit rating of issues that are obligations of the State.

 

From our perspective, we see room for the equity markets to advance further during 2013; the fundamentals that underlie the prices of the stock market indices show that the new record highs are not necessarily the end of the story. As corporate earnings grow, higher stock prices should follow. We expect equities to outperform bonds in the year ahead and see investors moving toward alternatives to bonds, as long as low interest rates persist.

 

Back to my phone conversation with Dad… By the end of the phone call, he decided that it was better to stay in the market and be invested for the long term. We think so too!  

 

Call your United Bank & Trust investment professional if you have questions about investing in today’s complicated market environment.