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Thomas J. Feeney's Measure of Value offers periodic commentary on leading financial issues of the day. Additionally, we present occasional articles explaining the philosophical underpinnings of the investment approach that our firms have employed successfully since 1986. Our thinking frequently differs from the common wisdom of the investment industry. The investment approaches we employ always recognize this as a probability business, not a certainty business. In evaluating any investment action, we always weigh the potential damage should the market prove us wrong.

While we have great respect for investment history, we recognize that each era introduces unprecedented specifics. In all that we do, we attempt to identify value, in both a relative and absolute sense. History has demonstrated that long run investment performance leaders need not be the leaders in bull markets as long as they avoid giving up significant portions of their assets during bear markets.

We firmly believe that one need not be fully invested at all times. In fact, we far prefer to assume relatively large levels of risk when assets are historically cheap and to be heavily risk-averse when assets are historically expensive. This approach has proven successful for our clients over more than a quarter century.


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The powerful post-election stock market rally has turned a great many skeptics into hopeful, if not confident, speculators.  And while momentum should never be discounted, there are numerous reasons to pay close attention to contrasting risk and reward possibilities.

Events of the past several months—the Brexit vote, the Trump election and the Italian referendum— have cast grave doubt on the predictive accuracy of the world’s major pollsters.  Such surprise results have emboldened those looking for outlier outcomes.  And while low probability outcomes will periodically occur, oft-repeated precedent is a far safer bet.  Let’s examine today’s stock market conditions on a probability scale.

Many market commentators have dubbed the recent strong rally in U.S. stocks the “Trump rally”, and there can be no doubt but that many people have strong expectations that proposed regulation reduction, tax cuts and foreign profit repatriation will do marvels for corporate profits and, in turn, stock prices.  They have either ignored or downplayed the potential negative economic effects of proposed tariffs and more restrictive immigration.  However the interplay of those factors may unfold, it is unlikely that many proposed changes will have an immediate significant effect.  And while Trump will have a Republican majority in both houses of Congress, a sizeable number of far-right members of his party have developed their political careers on the principle of reduced debt and deficits.  It seems highly unlikely that they will find massive infrastructure spending an appetizing prospect.

The most optimistic bulls seem to believe that Trump brings to the presidency a “can do” spirit that will overcome objections on such mundane grounds as excessive debt.  Many project parallels to the positive effects on the economy and the stock market that unfolded through the eight-year presidency of Ronald Reagan.  While similar results could happen, dramatically different conditions exist today than at the beginning of the Reagan years.

The excellent Ned Davis Research Group outlined several striking differences between the two eras.  Reagan lowered the top income tax rate from 70% to 28%.  That same potential doesn’t exist today with a top tax rate of 39.6%.  Inflation was in double digits when Reagan took office but had begun its steep plunge to low single digits through most of the Reagan years.  Trump inherits low single digit inflation, which the Fed and all major world central banks are trying to push higher.  Having flooded their respective economies with freshly minted money, countries around the world face the potential of surging inflation if disinflationary forces fade and extreme money creation produces its historically normal result.

Interest rates declined through most of the Reagan years, but Trump appears ready to assume office with rates rising and forecasted to rise further by the Fed and almost all private forecasters.  Government debt was below $1 trillion when Reagan took office.  It will be more than 21 times that amount when Trump takes the oath of office.  With debt at such an extreme level, rising interest rates could have a devastating effect on the nation’s finances.

At the beginning of the 1980s, Reagan inherited a stock market that had been suffering through a long weak cycle since the mid-1960s and was trading at extremely low levels of valuation with price to earnings ratios in single digits.  By contrast, Trump takes office after eight years of a central bank-fueled stock market rally that has pushed U.S. broad market valuation levels to the second highest ever, trailing only those of the dot.com era at the turn of the century.  Today’s median stock is at its greatest valuation extreme ever.

Throughout global history, extreme levels of overvaluation have always returned to long-term norms by price declines, not by underlying fundamentals rising to meet elevated prices.  In the current instance, however, central bankers have successfully prevented stock prices from reverting to their historic means by verbal intervention and by unprecedented monetary largesse whenever prices appeared to be in danger of more than a moderate decline.  Investors are left with what we have characterized as “the bet”: a) whether to count on continuing central bank success in supporting overvalued stock prices or b) to expect a reversion of stock prices to their historic norms.

We continue to urge investors to evaluate not just the probability of rising or falling prices but also the potential degree of increase or decrease.  While there is no way to know how high a price ceiling might be, more than a century of data indicates that the growth potential over the next decade from even lower levels of valuation is minimal.  On the downside, when valuation excesses have been unwound in the past, many years of profit have been erased.  Most recently, the 57% stock market decline from late-2007 to early-2009 took prices back to 1996 levels.  Earlier market declines eliminated even more than 13 years of gains.  Retreats from severe levels of overvaluation can be devastating, no matter how long deferred.

Returning to more immediate matters, the current post-election rally is normal, although stronger than most.  Roughly 80% of the time, stocks rally from election day to the new president’s inauguration.  That pattern, however, has not typically foretold a continuation of the rally.  The first year of the four-year election cycle is on average the weakest, especially in the second half of the year.  Over the past 80 years, post-inauguration weakness has been especially pronounced when Republican presidents have succeeded Democrats, although the sample size of four is very small.  The average decline from inauguration through September of the first year has been about 13% in the Eisenhower, Nixon, Reagan and Bush administrations.  While the full eight years of the Reagan presidency saw good gains, the early years included a recession and a 25% market correction.  In fact, every Republican president in the past 70 years, with or without a majority in the House and Senate, experienced a recession in the first two years of his presidency.  A recession with valuations anywhere near today’s levels would likely lead to severe stock market losses.

With U.S. stock prices close to all-time highs and investor sentiment improving, it’s hard to imagine a drastic change in the near term.  And, frankly, many technical readings of supply and demand and new highs and lows point to likely higher prices in the months immediately ahead.  That makes “the bet” both confusing and dangerous.  Nobody likes to miss upside opportunities, but when stocks are severely overvalued, an unexpected economic, political or military event can crush stock prices very quickly.  The most dramatic example of a sudden change of sentiment and market direction followed the 1928 election of Herbert Hoover.  The new president was seen to be an excellent candidate to continue the strength of the Roaring Twenties, and stocks jumped by double digits between election day and his March 4 inauguration in 1929.  Positive sentiment continued for a few more months only to be extinguished late that same year by the most devastating stock market crash in this country’s history.  Thus began the Great Depression of the 1930s, exacerbated by isolationism and protectionism, which led to widespread trade wars.  President-elect Trump and politicians worldwide are campaigning on nationalistic themes that were direct forerunners of the trade wars that crippled world trade in the 1930s.  The dangers are there again today.  We can only hope that the world will not proceed too far down that potentially destructive path.

Adding to stock holdings at current levels will prove profitable only if prices never again dip below today’s level or if prices go higher and sales are strategically timed before a later decline.  Neither is a high probability option.

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Tom Feeney is Chief Investment Officer for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more, you are invited to email your interest to Tom@missiontrust.com or call (520) 577-5559 to speak with one of the Portfolio Coordinators.

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