Do equities deserve a careful look going forward?
The year 2019 was great for equities, with the S&P 500, the benchmark US stock index, printing a record high. Most companies have beat positive analyst expectations to seal a year that has literally enriched equity investors. All the clouds that would have dimmed the sunshine, such as US-China trade tussles and an immature inverted yield curve, have since faded away, with investors now imagining how much higher the markets will rise.
The Sky is the Limit
But here is how high it has risen thus far. The S&P 500 is at circa 145% of the US GDP. For perspective, during the high valuations of 2007, just before the global financial crisis, the benchmark index was priced at just above 75% of the GDP. The current level is just shy of the temporary high of the tech bubble, at the turn of the millennium, which topped at just above 161% of the GDP. Over the last couple of years, S&P 500 revenues have grown marginally. The current high valuations have ensured that the S&P 500 is now trading at 2.25x revenues, which is even much higher than the multiple of 1.77 during the 2000s tech bubble. All these clearly confirm that US stocks have performed admirably in 2019 but concerns of overvaluation are real and logical.
How We Got Here…
In the aftermath of the 2008 global financial crisis, there was increased government spending as well as cheap credit that helped the economic recovery. In 2019 specifically, the equities market has benefitted from a strong and positive economic and monetary environment. The Trump administration has boosted government spending, while the labour market is now at full employment. Investors have interpreted this as a positive market for companies’ goods and services. On the monetary side, the US Federal Reserve has cut interest rates thrice in 2019 to provide a major tailwind for US stocks.
No one knows the future, but investors are rightly concerned of heavy downside risks. We are currently in the longest streak of bullish gains, and a cycle of bust is nigh. There might still be room for some gains, but naturally, an overvalued market offers a less attractive risk/reward ratio. Investor caution is always witnessed during real or perceived market highs, such as the current one in the equities market. The desire to take risk off the table or even to rebalance their portfolios, may at best stall the market or at worst, trigger a downward spiral.
Positive US-China trade talks also boosted investor sentiment in the markets. There is however the danger that the talks will continue sideways, with no clear positive direction. Alongside a change in the Federal Reserve stance from dovish to neutral, there might not be enough fuel to propel stocks to further heights going forward.
Who is at Risk?
Every investor will be at risk in case a downturn occurs in the equities market. But a particular demographic will be more exposed. The millions of US workers that enter retirement every year have little room to ride any retracement or downturn in the market. This lot has spent the last decade recovering and boosting their capital levels following great losses experienced during the 2008 global financial crisis. They will surely have no desire to ride another decade of retracements or a bust cycle. For this group, booking profits makes a lot of sense or using other strategies of avoiding risk, such as prudent portfolio rebalancing.
The S&P 500 has a long history of being net positive, which means that younger investors may exercise patience going forward and may still emerge as winners even if things turn bad in the medium term.
But this may not be exactly necessary.
Volatility is expected in equities, but this does not mean that profits may be hard to come by. The uncertainty may mean that stock CFDs offer great opportunity for investors to continue churning out big profits out of the equities market. Trading stock CFDs mimics traditional share trading, but with a few key differences and major benefits.
When you buy a stock CFD, you do not own shares in the underlying company, and will not have voting rights or benefit from profit sharing in the form of dividends. A stock CFD allows you to trade the price movement of the underlying company’s shares. This means that both rising and falling markets offer profit opportunities to investors. Leverage is also a major benefit of trading stock CFDs; you only need to place a small margin capital to control a large stock trade position. While this magnifies both your expected profits and losses, it effectively ensures that the overall risk capital is as low as possible.
The current state of the equities market requires a prudent risk management strategy. With stocks overvalued, the incentive to hold on to potential further gains is weak. Stock CFDs offer a lucrative proposition for boosting profits if volatility kicks in within the equities market.