Common Sense Says Market Will Hold Steady

 | Jun 15, 2016 | 2:30 PM EDT
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I read a lot. Daily, I read The Wall Street Journal, The Financial Times, USA Today and The New York Times. Other regular readings include Barron's, BusinessWeek, The Economist, Fortune, Forbes, The New Yorker and the Harvard Business Review. Wedged in between all that are annual reports, books, industry reports and government agency reports. I top it off with quality real-time news and articles from the Internet like the place you are reading this article, Real Money

Needless to say, when you read like this, you will always get both sides on any issue. But in aggregate, what this consumption of information does is allow me to apply a healthy dose of common sense and rationality to investing and the stock market. 

Rational thought is invaluable, especially now. We are inside an eight-year bull market for U.S. stocks, so there is a loud chorus that a major crash is coming. Instead of deciding which side I want to fall on, I prefer to peel back as many facts as possible and then make an intelligent assessment of where we are heading. 

My first observation is that all the really major catastrophic market declines have come during periods of severe economic distress. That's not the case right now. The unemployment rate (let's focus on the number that is widely reported) is under 5%. Banks, whether you like them or not, are more regulated and are not making foolish loans. Also, while equity prices are quite full, they are not remotely close to nosebleed valuations.

So common sense tells me that markets are likely to bounce in a range as opposed to surge higher or tank lower at the moment. Obviously, the outcome changes depending on how the market behaves, but at present, equities will likely hold their own. Common sense also suggests that when interest rates are zero, it makes sense to pay up for assets. Warren Buffett said this precise thing at his annual shareholders meeting: Because of low interest rates, he was willing to pay more for Precision Castparts (PCP). 

So even at current market levels, if the future expected return of stock is 5% to 7% a year, that's a significant premium above 0% for the risk incurred. I suspect that under the current scenario, notwithstanding short-term effects as a result of the Brexit vote, presidential election or other political or economic event, the market will not collapse, but rather continue to plug along. As such, investing in quality assets at fair valuations or in distressed situations is not out of reason today.

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