Several weeks ago stocks were falling on global concerns due to the vote in Britain to leave the European Union. Since that event, stocks have recovered their losses, and have established new highs, as measured by the broad based S&P 500.
Obviously this kind of price action can leave investors confused. It certainly raises the question whether Britain leaving the European Union is all that significant.
As was discussed in a previous column, I did not feel that the vote in Britain would have too much of an impact on the U.S. economy. The significance would be more in Europe, and certainly companies doing business in that region would be affected some..
While the initial reaction to Britain leaving the European Union was negative, investors appear to be reassessing the implications of that move. Most likely the negative impacts to the global economy will not be as significant, as some had feared. This whole process will take years, and investors are starting to focus on other events.
What appears to be the most significant factor driving stocks higher is that interest rates are at extremely low levels. When investors are faced with a choice of earning a very small return on a fixed income investment, purchasing stocks looks relatively more attractive.
Another factor helping the stock market is that the economy remains quite steady. The employment report for the month of June was quite strong relative to recent months. This helped to alleviate fears about the economy slowing down.
A point to consider is that the stock market reaching a record high should not be considered to be an unusual event. Over time with an expanding economy and increasing corporate earnings stocks should be increasing in value.
This same characteristic holds for real estate. Most years real estate prices are rising, though as with stocks there can be times real estate prices fall, which is generally in a recessionary environment.
Some investors might be concerned that buying at a record high means that stocks are overpriced. There have been times when stocks have become overpriced due to euphoria, but generally speaking a record high does not mean overvaluation.
In most cases, in a year where stocks establish record prices, there will be many other days when new highs will be reached. For the most part just because stocks are at record highs does not mean that an investor needs to change their course of action.
A sign that prices could be inflated is when stocks increase significantly in value, such as over 20%, when there is little change in the fundamental economic outlook. In the present environment there has been little change in the economic outlook, but stock market prices are only slightly higher than they were a year ago.
Barring any unusual event, the present economic environment will likely stay in place for the time being. Even with the stock market at record highs, stocks still appear to be somewhat more attractive relative to bonds because interest rates are at such a low level.
With the stock market at current levels it would be an appropriate time for investors to reassess their asset allocation. For example if someone has a long term target of 60% in stocks, and it has grown to be 70%, now might be a good time to reduce that weighting back to its normal level. Other than reviewing one’s asset allocation I don’t believe that stocks reaching record highs should cause someone to change their course of action.I
