These Two Factors Matter Most For The Stock Market

Victoria advises high net worth individuals and businesses on money matters. Visit her website to learn more.

We’ve finally made it through the dumpster fire of 2020. Back in March, it seemed like the world was ending. The country was experiencing the worst economic decline since the Great Depression. December was light-years away. But here we are, ready to say sayonara to this calendar year and head into the next with (hopefully) greater perspective, gratitude, and a pattern of navigation through this “new normal.”

It’s a bit ironic, isn’t it? When the market was going down precipitously in February and March, many investors wanted nothing to do with stocks. Now that the major indices have hit new all-time highs, many investors again want nothing to do with stocks. The market can’t win for losing, it seems. There’s never a “right” time to invest. There’s never a time that feels good. As painful as it is to buy as the market is falling apart, it’s painful to buy at the top also. Is now really a good time to invest, with the market at all-time highs?

Let’s put this into perspective. Yes, the market has had an incredible rally off the March 23 lows. But pull back the lens a bit. When you draw a line from January 1 through today, the returns haven’t been out of line.

“But what about Covid-19, negative GDP, the recession, political unrest, unemployment and (fill in the blank with your biggest fear here)?” some ask. I know of several investors who moved to cash in March because in their minds, there was no possible way this wouldn’t be a market catastrophe on par with the Great Depression. They’re still waiting for that second shoe to drop. In my opinion, it’s an exercise in futility. I don’t think we’ll see those March lows again. And here’s why.

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This is one of the most important lessons in investing. If you can understand this, it will save you a lot of pain and mistakes. What you have to understand is what really matters to the stock market. And despite what your intuition (or the news) is telling you about how bad things are, you have to look past that toward what’s going on under the surface.

Many things matter, but two things top them all: interest rates and liquidity. I’ve said this in the past, but it’s worth repeating. Trust me. I used to be firmly in the fundamental valuation camp. I believed in mean regression. Like a rubber band, you can stretch one or two standard deviations from the average, but sooner or later, we’ll snap back to average. If the S&P 500 is trading for 1.5 standard deviations above its 20-year average, common sense would say it’s overvalued. And why would someone invest in something trading for more than it’s worth?

Here’s the fallacy in that thinking. It assumes that everything else stays the same. If interest rates, liquidity, debt, consumer spending, GDP and earnings were all at a stable growth rate for the past 20 years, only then could we say that an index was undervalued or overvalued based on that measure.

But those things haven’t stayed the same. There are now record low interest rates, low consumer debt, high government debt due to stimulus measures, consumer spending that has shifted to different locations, negative but rapidly improving GDP, and a bifurcation of earnings (some sectors are booming while others are languishing).

When you factor in the shift that has happened in the factors that matter, you can then make an educated guess on where the market may go over the next 12 months or so. And with near 0% rates and a firehose of money that more than makes up for GDP loss, it’s my opinion that the S&P 500 could see double-digit returns in 2021. Of course, that does mean smooth sailing. I still think the market will create some seasickness among all but the most experienced of sailors. And as we’ve all acutely experienced in 2020, the unforeseen can and does often happen. But from where I sit now, with the information I have, my call is for a positive 2021.

Let’s get back to that question of whether now is a good time to invest. I would say yes, but not blindly. One investment strategy is to use as many tailwinds to your advantage as possible. What does that mean? It means finding the sectors showing a strong trend compared to the broad market and purchasing securities that are showing strong trends compared to their strong sectors. It means purchasing what institutional investors are accumulating. It also includes sticking with companies that have beaten their earnings and raised guidance and staying away from companies and sectors that are languishing and showing no consistent momentum or investor support. Don’t try to catch falling knives, and don’t try to time the bottom of a bad stock. The secret of making good returns in the stock market isn’t to buy low and sell high. It’s to buy high and sell higher.

I hope you keep these factors in mind as you invest in the coming year. May your Christmas be merry and bright, and may your new year be full of new possibilities.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.


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