Going through my virtual mailbag I came across a great question: “Where’s the market going in the next three years?”
Most of the time there just isn’t enough clarity into the market to be able to make this sort of a prediction. But right now you don’t have to twist my arm to get me to make a call.
When you look at the current state of the market it’s like having flash backs to the 90s. Honestly, this market is almost identical to state of the market in ’95 and ‘96. Last year most resembles 1995 and this year is following the path of 1996. If you take a look at the figure below, I plotted two charts to show you how similar they are.
So what is driving the market to move in such a similar pattern? It has to do with interest rates.
Like in ’95 and ’96 interest rates on cash and cash equivalents is very low while dividends from publically-traded companies is on the rise. Companies can borrow very cheaply to raise capital, fund expansion and boost dividends and attract investors.
In this environment, frustrated fixed income investors move their money over to the stock market in search of higher yield. That’s what happened in the 1990s and exactly what’s happening now. The stock market has higher yields than the bank and money is on the move.
What does this have to do with my three-year outlook for the market? Well, the market rallied for four additional years following the ’95 and ’96 rally with an average gain of 28.7%.
Now, we all know what happened at the end of that four year rally. The bubble that formed and burst was not just because money was going into the market, it was because of indexing. Let me explain.
In the 90s you may not have known that when you bought an S&P 500 index fund that 50% of your money went into just seven giant tech stocks. You may have been buying an index of 500 stocks, but really you were putting your money in just seven. I wouldn’t recommend that strategy to any investor at any age or with any portfolio value.
It’s no surprise that that a bubble formed under Silicon Valley, under Cisco, and Oracle, and other big tech stocks. That’s why you have to be careful when indexing, it’s often less diversified than you would think.
We don’t have that risk in the current market and for those reasons, and many more, my outlook is very bullish.
I wouldn’t recommend that you go out and buy any stock, every market no matter how strong experiences pullbacks and not every stock rises. So be sure to run each stock through Portfolio Grader and watch for grade changes each week so you know when it’s time to get in and out.