April 19, 2017 | by Scott Miller, Jr.
I recently walked into a local deli and noticed a sign proudly displayed which read, “78 Days without an accident.” I assume that between the knives, meat slicers and grill, 78 days is quite an accomplishment. The Dow Jones Industrial Average bested that streak going 109 days without a closing drop of more than 1%. The streak ended on March 21st with a fall of 1.1%. Casual followers of the stock market may have assumed that the Federal Reserve raising rates the prior week caused the market to fall. After all, raising rates has served as a constant worry to the markets as financial programs and articles have speculated on what higher rates would mean and how much it would hurt equities. Interest rates were increased by a quarter point in March but that was not what caused the streak to end, rather it was the impending repeal of the Affordable Care Act. As it became more apparent that a deal would not be reached it became clear that “The Dealmaker” could not secure the deal. Suddenly the Trump economic agenda came into focus, what would this mean for tax reform, deregulation, and other economic policies? For the first time since the election, the markets questioned how much the new administration will be able to accomplish?
Is the “Trump Rally” overdone? If we use a Price to Earnings ratio, the answer is yes. The current forward P/E is 17.5x while the 25 year average is 15.9x. This translates to a current overvaluation of approximately 10% based on a constant multiple. However, this does not necessarily mean that it is time to sell as expensive markets can become more expensive. Sure the market could fall 10% to match historical valuations or the markets could fall 20% and become undervalued. Conversely, overvaluation may just mean that the market is borrowing from future returns. For example instead of returning 6% per year for the next five years the market may only return 4%. In other words, the economy may grow into valuations. Above average valuations may also be justified if tax policy and or deregulation creates a foundation for earnings growth above forecasts. While markets are slightly overvalued, we believe that remaining invested but in a hedged manner is the best strategy. Hedging may reduce returns in a bull market but also will mitigate losses in down markets. In a market slightly overvalued, the upside returns that hedging may decrease means less while the reduction of losses in down markets should give investors the courage to remain invested.
What most of our investors should not do is change their strategy. Too often accounts are brought to us where there have been several strategy changes. I always wonder if those changes were made to help the client or help the broker who was paid a commission every time a change was made. Even worse, with commissioned brokers it appears that they are always investing clients’ money in what just did well and not necessarily what will do well. If you are earning a commission and trying to convince someone to buy, it is always easier touting tremendous recent performance. The problem is that the market is cyclical. It leads to a constant problem of chasing performance and buying at the wrong time. We are fee-only, fiduciary investment advisors as opposed to fee-based advisors or commissioned oriented advisors. We have no inherent conflict of interest as we don’t accept fees or commissions based on product sales. Our goal is to provide comprehensive, unbiased investment advice at a reasonable cost. We provide a hedged strategy using options and index-linked notes that most commissioned brokers wouldn’t offer because they lack sales incentives. In addition, there are tremendous opportunities to uncover value in the CEF space, but it is not easy and takes signifigant time and effort. Typically commissioned brokers are not going to spend the time and effort on investments that do not pay well. This is the case with CEFs (except for the IPO when brokers are paid handsomely). As fee-only advisors, changes to your account are made with care and purpose, which is essential in any market environment.
There are many way to simplify your financial life and we are eager to be of assistance in any way we can. As always, we appreciate the confidence you place in us.