Written By Millionaire’s Digest Team Member: Eric Bruin
Founder & Owner of: The Stock Trader Blog
Millionaire’s Digest Team, Contributor, Books, Business, Education, Entrepreneur, Politics and Successful Living Writer
Modern portfolio theory, even with its limitations, has significantly helped investors accomplish their financial goals for the past 65 years. Harry Markowitz, the father of MPT, helped more people become millionaires than nearly anyone else in the history of finance (I know of only two other people who contributed more). For investors of all ages, diversification is now a requirement for sound investment. Whether you have a 401k, IRA, pension plan, or brokerage account, your diversified investment positions are likely going to change over the next year due to movements in the overall market.
As you go into 2017, keep in mind the following 4 factors as you weigh investment opportunities:
1) Perhaps the most important factor for 2017 investments, the U.S. stock market is at all-time highs. Not to get too technical, but the S&P’s cyclically-adjusted P/E (price to earnings ratio using a 10 year average of corporate America’s earnings) sits at 27.92. The S&P’s P/E ratio using earnings from the past 12 months is 25.98. A high P/E ratio suggests an asset is expensive and perhaps riskier.
To put those two ratios into perspective, the historical average price-to-earnings ratio of the S&P 500 is about 16.7. This means that investors are currently paying way more for stocks than they have paid on average for the last 100+ years.
On any given day, there are conservatively priced stocks and overpriced stocks. By diversifying, investors are effectively buying both the cheap stocks and the overpriced stocks. Doing that in 2017 may be problematic. Most indicators show there are more overpriced stocks than cheap stocks in today’s market. If the market reverts back to its historical mean, investments in the market indexes will suffer significant losses because the overweighted position in-expensive stocks will lose more money than the position in cheap stocks will make money.
2) The Trump administration will likely implement significant change. We are seeing a preview of this already, nearly on a daily basis, and any form of uncertainty tends to rattle financial markets. Until the President-elect takes office, it is impossible to accurately forecast what changes will be made, when they will be made, or how they will be made.
3) Interest rates in the U.S. are back on the rise again. Generally speaking, this makes investing in stocks less attractive. The good thing is interest rates are rising at a sluggish pace which lessens the probability of credit shocks. It is still very important to consider going forward.
4) The covariance relationships of many financial assets seem to be diverging from historical patterns. Take today, January 3rd, for example. The S&P 500 went +.85%, the spot price for gold went +.63%, the volatility index (VIX) went -8.48%, and the U.S. dollar index went +.85%.
Stock prices and gold prices usually only rise together when the U.S. dollar loses value because it takes more dollars to buy them when the dollar declines. A strong dollar hurts U.S. multinational companies, and it implies the economy is strong. Gold is an asset of safety. Yet all three of them gained value.
Furthermore, gold and the VIX tend to move in the same direction when one of them moves a lot. The VIX made a huge move today. Yet gold moved in the opposite direction. What happened in the market today does not make any sense. At least two of these assets are likely mispriced which adds more uncertainty to investing throughout 2017.
To sum it up: Stocks are at all-time highs, Trump is still new on the scene, interest rates are back in fashion, and the relationships of different financial assets are signaling a massive amount of speculation (betting) is taking place.
2017 will definitely be captivating for investors.
Article Credits: Eric Bruin
Millionaire’s Digest Team, Contributor