Hope Is Not A Long-Term Strategy

4/2/2017 – If you find that your investment strategy is pinned on the hope that Congress will somehow pass economic-boosting legislation in a timely manner, you may want to reconsider your thought process. There is worry that Republicans will begin to distance themselves from President Trump amid his falling approval rating and after they failed to repeal and replace the Affordable Care Act. If Republicans begin to distance themselves, I believe there is little chance that any of President Trump’s proposed economic policies will get passed. Of course, this will undoubtedly not be good for the equity markets. Therefore, the question we should all be asking ourselves is, “after reaching new market highs, where do we go from here?”

To help frame this question, it helps to understand how we got here. The current bull market is one for the ages. We are currently experiencing the 2nd longest bull market in history: 2,946 days.

When this bull market began, very few, if any, would’ve guessed that this rally would’ve been so strong or so long. Though, this can also be said about many market rallies throughout history. Bull markets typically begin when optimism is scarce and they frequently end when optimism is abundant.

This particular bull market is unique as it has been characterized by extreme central bank intervention. This intervention has created a massive wealth effect by boosting asset prices around the globe. While the Federal Reserve has ceased its asset purchase program on October 31, 2014, there is still plenty of liquidity still being added into the markets. And make no mistake, a lot of this capital is continuing to find its way to U.S. assets.

After the Fed ceased its asset purchase program on October 31, 2014, the market struggled to maintain its momentum. During the two-year period between November 1, 2014 to October 31, 2016, the market moved sideways with high levels of volatility. Market returns was dampened by falling corporate earnings, Chinese growth concerns, and falling industrial production.

S&P 500 – 11/1/2014 to 10/31/16

Of course, in November 2016 President Trump shocked the world by winning the U.S. election. Between November 9, 2016 (the day after the U.S. Presidential election) and March 31, 2017 the S&P 500 rallied 9.22%. Coincidentally, Consumer Confidence has also rallied to near historic highs.

So, where do we go from here? There is a deepening divide within the investment community on what will drive the markets higher. Some believe that corporate earnings will continue to recover. Others believe that President Trump and the Republican-led Congress would be able to reform the tax code, repatriate foreign-held corporate cash, rebuild America’s failing infrastructure, and create other economic-boosting projects.

However, there is growing concern that President Trump and the Republican-led Congress will be unable to pass these measures. The failure to repeal and replace the Affordable Care Act has caused some to doubt that few if any of Trump’s fiscal policies will be passed in a timely manner. Merely hoping that they will pass, in my opinion, can be an ill-fated investment strategy. Though, if the major central banks continue to provide an accommodative policy and if capital continues to flow to the U.S., we may continue to see equity prices pushed higher.

I believe that the equity markets will always have an upward bias so as long as there are educated individuals, fair laws, and access to capital. As such, I am convinced that the equity markets will continue to outperform over the longterm. That being said, equity markets often appreciate much faster than the underlying economy does. Furthermore, central bank intervention is certainly continuing to skew the markets. This “rich asset price” party will not continue forever. Volatility is near all-time lows and tail-risk is likely extraordinarily high. If there was ever a time to hedge some risk, now is probably the time to do so.

Ryan Hughes
Bull Oak Capital
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