Predicting the future is meaningless if you don't know what actions to take.

Dear Shareholder,

This past spring, I got invited to a lot of weddings. It seems the most common two conversation starters at these events are “how do you know so-and-so?” and “what do you do for work?” Once I reveal my profession, the wedding conversations turn to how the stock market is due for a correction. The people I’m speaking with are usually seeking confirmation, but I don’t offer it. Instead, I steer the conversation toward more fertile ground by asking two simple questions.

What if you’re wrong?

While it’s true that the U.S. unemployment rate is at its lowest rate in a decade, did you know that the labor participation rate is considerably below its historical average? In fact, it’s at levels not seen since the 1970s. Yet at the same time, the employment-to-population ratio is strongly rising. The trend is healthy as more people are coming back to work.

How about debt? Household debt service levels are near their lowest levels ever, meaning disposable income is near an all-time high. Whether this disposable income is spent, leading to sales and profit growth for U.S. companies, or saved -- and possibly invested in stocks to drive prices higher -- the result is unlikely to support a lasting market slide.

There’s also concern that with the baby boomers aging, there may not be enough spending to spur the economy along. However, according to projections by the U.S. Census Bureau based on the 2010 census the most common age in the U.S. is 26, and the number of 30- to 39-year-olds is poised to accelerate from 43 million to 49 million over the next decade. From a demographic standpoint, the U.S. is in good shape. The Bureau of Labor Statistics tells us the largest increases in consumer expenditures come as citizens hit the 25- to 34-year-old and 35- to 44-year old cohorts.  

Finally, consider that stocks are subject to the fundamental law of supply and demand. On the supply side, the number of public companies in the U.S. has fallen more than 35% since 1997. On the demand side, only 52% of adults are invested in stocks directly or through funds of some sort. Lower supply and the potential for higher demand would support higher equilibrium prices.

At the point of taking about equilibrium prices, the person I’m speaking with usually resigns to the fact that there may be another side to the market-correction debate. But they haven’t answered the question yet: “What should you do if you’re wrong?”

The common answer, in its simplest form, is some version of “stay invested in stocks.” The data here is not intended to change any minds; it’s presented to open them. Predicting the future is hard, and there are real costs involved if you’re wrong.

What if you’re right?

The market-correction debate usually centers on the economic and equity market runs and valuation. I happily entertain a discussion on both.

We’ve had 10 economic recoveries since World War II. The average recovery has lasted 5.7 years, and the current recovery is now more than eight years long. Similarly, the S&P 500 is closing in on its ninth consecutive year of positive performance. This is an impressive run. A common refrain is that these streaks can’t last.

The S&P 500 appears expensive, trading at a price-to-earnings ratio above 24. This is rarefied air -- a level not seen outside the tech bubble. The cyclically adjusted price-to-earnings ratio, which takes a 10-year view, is now higher than it was during Black Tuesday in 1929 and Black Monday in 1987. Regardless of what valuation multiple one choses to look at, the conclusion is the same: The market is on the high side of historical normality.

At this point, the person I’m chatting with feels vindicated. And that’s when I ask, “What should you do if you’re right?”

Imagine what the combination of frustration and a blank stare looks like, because that’s what I usually see. All the responses I get end in question marks. Buy bonds? (Near record-low interest rates.) Buy gold? (Historically low returns.) Move to cash? (Zero capital appreciation.) Move to the cryptocurrency du jour? (There’s no history to help you know where to invest.) Short stocks? (You introduce catastrophic loss scenarios.)

In short: Predicting the future is meaningless unless there’s a clear action to take that can move you toward your goals.

Why you should consider to stay active

I believe the fundamentals of the economy and market are supportive of the potential for healthy returns. Yet I can assure you that the market will fall, possibly hard, at some point. Regardless of what the future holds, what really matters is positioning your capital to help you achieve your goals over time. There are two things you should consider.

First, lengthen your time frame. Why is 365 days the optimal measurement period? It’s reassuring that historically from 1927 to 2016 the market has risen in seven out of every 10 years, but it’s downright empowering to know that it rose over 85% of rolling five-year periods and 94% of rolling 10-year periods. Whether the market is due for a correction matters much less with a longer-term outlook. A key to staying invested is having an appropriate (ahem, long) time horizon.

Second, to give yourself a chance to avoid a market losing streak, invest differently from the market average. Losing streaks do happen (1929-1932, 1940-1941, 1973-1974, 2000-2002) and they’re assured for you if you invest passively and accept “average.” To get “different,” you must be different, and choosing to invest through an actively managed mutual fund -- like the Independence, Great America, and Emerging Markets funds – it may be a way to do so.

At this point, we’ve moved beyond awkward wedding conversation. Your team at Motley Fool Investment Management has internalized a “Stay Active” mantra. Our core investing belief is that independent research, conducted with a long-term mindset, will lead to outperformance. Conducting independent research ensures that we continuously depart from “average.” Maintaining a long-term mindset ensures that we’re constructing portfolios filled with companies we anticipate owning for years.

If you’re reading this, you’ve probably chosen to Stay Active. We commend you for this approach and thank you for the trust you put in our team. Independent research and a long-term mindset will continue to define our approach and differentiate us from others.

Onward,

Bryan Hinmon

Chief Investment Officer

Motley Fool Asset Management

 

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