During periods of economic expansion, people are normally willing to take on more risk. Likewise, when the economy is weaker individuals tend to be more risk averse.
When the economy is strong, there is a tendency for more people to start their own businesses. Clearly someone who goes out on their own is taking on more risk versus a person who is a salaried employee. Most people would not be willing to open a new business unless they had some reasonable expectation that they would be successful.
The stock market normally performs better when there is greater confidence in the economy. This confidence is often signified by consumers willing to spend, and also businesses willing to invest.
Looking at the current environment, we see a stock market that is not too far from its all time highs. However, at the same time we have an economy where new business formation and investment spending are relatively weak.
When looking at the stock market from this perspective, someone might think that the stock market should be weaker. However, there is some rationale for the current valuation among stocks.
Part of the reason for the stock market performing reasonably well is because interest rates continue to be at very low levels. The interest rate on 10-year Treasuries is only 1.6%, as of June 17. With the average dividend yield being over 2%, this makes stocks relatively attractive versus bonds.
If someone looks into greater detail how the stock market is performing, one will notice significant divergence by sectors. When the stock market is performing well, normally a good portion of the various market sectors are hitting all-time highs.
Of the 10 major sectors in the stock market, only two have reached all time highs in the past month. The two that have set new highs are Utilities and Consumer Staples, which are among the least economically sensitive sectors. Irrespective of how the economy is doing, consumers will continue to purchase food and use natural gas and electricity. In addition these sectors have higher dividend yields, which enhances their attractiveness.
For most investors how the overall market is doing is more important versus the performance of individual sectors. In a company retirement account investors will be invested in funds. An index fund will just replicate the performance of the overall market, though other funds may emphasize certain sectors of the market. For example a fund that emphasizes technology stocks did well last year, but is performing poorly in 2016.
Some people do own individual stocks, which is an option in an IRA account. For those who hold individual stocks it is important to be diversified. That means having representation across the various sectors of the market.
There is a tendency among some investors to want to emphasize parts of the market that are doing well at the present time. For 2016 that has been Consumer Staples, Utilities, and Telecom. However, what is doing well at the present time is not necessarily going to continue for an extended period of time.
What investors need to determine is whether the current economic environment should cause a change in investment strategy. For people with a long-term investment outlook there is really no reason to change strategy.
At the present time, investors overall are reasonably cautious, despite a stock market that has held up fairly well. The economy continues to give mixed readings with real estate strong and business investment weak. Most likely the economy will continue to give mixed readings for the immediate future.
