ETF Store Insight

Quarterly Update

October 10th, 2016 by Nathan Geraci

Nathan Geraci is President of The ETF Store, Inc. and host of the weekly radio show “The ETF Store Show“.

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“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” – Sir John Templeton

Between the contentious presidential election, negative discourse surrounding Federal Reserve monetary policy, lack of corporate earnings growth, Deutsche Bank’s financial struggles, Syria’s civil war – the list goes on and on; market sentiment is short on optimism and long on pessimism.  Recent headlines include:

  • “Donald Trump on the stock market: ‘It’s all a big bubble” – CNBC
  • “Mark Cuban: ‘Huge, huge’ losses for stocks if Trump wins” – CNN
  • “Fed holds fire on rates, avoids stock market shock” – USA Today
  • “Deutsche Bank crisis threatens to roil global markets” – MarketWatch

Yet, because of, or in spite of, the negativity, markets have continued to push higher.  After the worst beginning to a year for U.S. stocks in history, the S&P 500 is now up 8% year-to-date through the end of the third quarter.  Some refer to this as stocks “climbing a wall of worry”.  Negative headlines create uneasiness, resulting in a number of investors sitting on the sidelines while more fully committed investors profit from a generally positive environment – notwithstanding the headlines.  Regardless of whether you believe the markets are undervalued, fairly valued, or overvalued, most can agree on one thing:  the markets lack euphoria.

It seems the two most pressing concerns keeping a lid on investor enthusiasm are the prospect of the Federal Reserve raising interest rates and the upcoming presidential election.  Anytime there is even a whisper of the Fed hiking rates, markets go into full panic mode – ignoring the fact that a quarter point rate increase is largely inconsequential and stocks have historically performed well immediately following a rate increase.  According to Goldman Sachs, “In the last 32 policy-rate hike cycles globally, local equity markets gained a median 12% in the 12 months leading up to the start of the new rate cycle.”

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As it relates to the election, Wall Street is currently pricing in a Hillary Clinton victory, with Republicans maintaining control of Congress.  The consensus is that this would be positive for the markets, because the resulting gridlock in Washington would mean less uncertainty for investors.  With a Donald Trump victory, the school of thought is there would be more uncertainty and, therefore, the potential for higher market volatility. Regardless, attempting to handicap the market reaction to either outcome is a fool’s errand.  According to Charles Schwab, in the past sixteen election cycles since 1950, the S&P 500 finished positive in the first year of a presidential term only 56% of the time – slightly better than a coin flip.  In any event, as an advisory firm serving a diverse group of clients, we typically shy away from political discussions.  However, a little humor goes a long way, and given this particularly gut-wrenching election cycle, we will straddle the fence with this:

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Whether it’s the Fed, the election, Deutsche Bank, or Syria – the fact is, as an investor, there will always be something to keep you up at night.  We are bombarded with headlines 24/7, which magnifies this sense of worry.  Investing is not without risk.  Risk comes from uncertainty.  Uncertainty often comes from headlines.  Headlines are never going away.  Sir John Templeton, the famed investor and global fund pioneer, said “The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”  While we certainly do not believe we are in a period of maximum pessimism, we feel equally confident we are not in a period of maximum optimism either.  Negative headlines are creating a wall of worry, which has yet to crumble under the weight of euphoria.

One final note:  while investing obviously involves risk, if there is an area of concern right now, it is that investors have to take on more risk than usual to generate returns in this environment.  One of the most interesting charts we observed during the quarter came courtesy of The Wall Street Journal:

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In order to generate a 7.5% return, investors must now stomach nearly triple the volatility from just two decades ago.  Primarily as a result of low (and even negative) interest rates around the world, investors have been forced to pursue riskier investments to achieve the same level of return.  Ultimately, this is from where we believe the pessimism, or worry, in the markets stems.  While investing never feels entirely comfortable, it feels more uncomfortable than usual right now for many investors.  Investors sense the additional risk in their portfolios.  The challenge is properly balancing this risk with any potential reward.  This is a uniquely personal decision based on each investor’s particular situation.  At The ETF Store, we endeavor to properly calibrate the risk in your portfolio and ensure the correct investment plan is in place.  We also emphasize controlling investment costs, an important aspect of investing made even more critical in this environment.