The Rally Continues

Global stocks are up 16% for the year. It’s the strongest start since 1987 for the S&P 500, as large US stocks have gained 18.2% so far this year and touched new record highs. After last year’s sharp selloff, the subsequent recovery has left some wondering if the pendulum has again swung too far.

Optimism in stocks has continued despite weak earnings growth. With over 82% reporting first quarter results, earnings of S&P 500 companies have fallen 0.7% from Q1 of last year.

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While it may seem odd for stocks to rally amid low or even negative earnings growth, two crucial factors are at play. First, expectations for earnings were worse heading into the reporting period as analysts had slashed estimates for profits. The market was looking for nearly a 3% decline in profits ahead of this reporting season. Second, the stock market is forward-looking, always gauging the likelihood of profitability in quarters to come.

All this also increases the market’s P/E ratio, a popular measure of valuation. Price (the “P”) rises while earnings (the “E”) hold steady. A higher number places a greater onus on firms to deliver better results down the road. The S&P 500 has climbed to above 18 times earnings, placing it nearly on the 5-year average.

Investing and the 737 Max

This is not about Boeing’s stock.

Once the FAA clears Boeing’s 737 Max for flight again (which it likely will), you board a plane, pull out the information card from the seat pocket in front of you, and discover you are on a 737 Max.

You reassure yourself that it is unreasonable to worry. Reason starts to kick in; even while the problems were unknown, only two of thousands of flights experienced failure. Still, that doesn’t quell the feeling in your stomach. How can you be so sure all the problems are fixed?

Investing can trigger the same psychological and physiological responses. No matter how much research you may have done, nothing is for sure. Stocks may go up 65% of the time, but the losses hurt more than the gains feel good[1].

Even though a 737 Max is likely still safer than driving a car, the fear comes from a part of the brain that doesn’t respond to reason. It has kept humans from being eaten by lions for thousands of years, but it’s not helpful for long-term investing.

Humans are emotional beings. Marketing experts know that we make emotional decisions and then only backfill the justification. Do you want to buy stocks today? Your mood may determine the answer more than your adept analysis of the economy and the markets.

What It All Means

This week trade negotiations returned to the top of investor’s minds. The markets are taking the headlines as an excuse to pull back from the new highs. Is a trade deal crucial for the market to move higher or is this the story simply falling at our finger tips?

The current trade talks with China could either be a flash in the pan or a sign that globalization has run its course. One way to protect against damaging effects of a secular decline to global trade is to diversify internationally. Less trade among countries de-links business cycles across countries and economies. It may also increase the chance of war. International diversification can help protect investors from any one country’s pain weighing heavily on a portfolio.

Taking the emotion out of investing is impossible. It’s hard to be agnostic about investing when it has a direct influence over your future lifestyle. But managing it is crucial for long-run success. The goal for the amateur and professional investor alike is to develop awareness of these emotions, seeking ways to improve the decision-making process.

We are here to help.

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[1] The MSCI All-Country World Index has had positive returns 64.9% of the months since January 1988.