As summer draws to a close and the calendar turns to fall investors are contemplating how 2013 will finish. Using corporate earnings as a clue raises questions about the sustainability of the stock rally. The May announcement from the Federal Reserve regarding tapering their financial stimulus blistered bond investors over the summer. Second quarter earnings were up modestly from a year ago but excluding financial stocks (who are the primary beneficiaries of Fed stimulus) earnings were down from last year. Evidence is mounting that the Affordable Care Act (aka Obamacare) is pushing employers to shed jobs, cut hours and healthcare benefits.
China and their emerging markets counterparts are still trying to grow in a no-growth global economy but it is getting harder and harder to sustain. Since the recession ended in 2009 our economy has created about 6 million jobs domestically. China graduated 7 million from universities this summer alone. Their economy is one fourth the size of the US economy yet they have to create as many jobs each year as we have in 4 years.
With so many reasons to be concerned about stocks, bonds, commodities and every other asset class, I would expect investors to be exercising caution. Instead I have observed a number of instances where investors are willing, if not eager to throw caution to the wind and buy into the stock rally (whose duration now longer than the average rally). It appears that investors are acting on the notion that stocks are the only asset class to be in. As we have shared before, Warren Buffett has encapsulated his successful investment philosophy as, “Be greedy when others are fearful and fearful when others are greedy.” At present, the inverse of this thinking appears to be driving investor behavior.
Calling market tops is useless conjecture. Observing historical precedents and applying empirical rigor to your investment process is prudent asset management. To employ Buffett’s aphorism, investors need to learn how to sell when everyone else is buying, wait patiently and buy when everyone else is selling. Emotionally this is easy to say but very difficult to practice. I summarized our portfolio rebalancing actions to a new client last month by observing, “This is what selling high feels like.”