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Stock Rewards & Risks

April 11, 2019

Stocks are up nearly 15% year to date, as tracked by the S&P 500 Index. That’s astonishing given that last year from the start to the top in September, the S&P 500 Index was up only 9.62%.

So, what’s driving all of the buying?

No. 1 is FOMO, or the “fear of missing out”—a powerful motivator in the markets.

The idea that if you don’t get in and buy that you’ll miss out on the big rally is getting more investors to unpark their cash and get it into the market.

And as the market builds on its gains, it only helps to fuel the buying. This isn’t a new phenomenon. Look at any of the big rallies of the past decades—FOMO kicks in and remains until fear takes over after some big down days.

No. 2 is the Federal Open Market Committee (FOMC). The FOMC and its Chairman bungled its messaging last year.

The FOMC laid out the plan to watch core inflation, as measured by the Personal Consumption Expenditure Index (PCE). It wanted to see the PCE reach 2% or more before it would act. Then the FOMC acted anyway, reducing its massive bond portfolio and stoking fears of more aggressive actions alongside raising its target range for the federal funds rate.

Then, with the stock market slipping and political pressure mounting, the FOMC punted. Now it’s going to be passive for a while. And with interest rates still not far from post-crisis levels, the credit market supports a buoyant stock market.

Moving it forward is the concept of Modern Monetary Theory (MMT). This is a new spin on an old theory from German economist George Knapp. Basically, MMT holds that a government that issues fiat money (like the US) can do so largely at will and can control inflation via taxes or bond issuance.

This way, the government can spend nearly at will. Of course, this works until it doesn’t. When its currency is no longer considered relevant, no one will buy government bonds except the central bank.

However, it is being rolled out as a politically pleasing means of not only keeping the FOMC’s bond portfolio intact, but potentially for having even larger government budgetary spending for all sorts of things. It’s also a convenient political explanation for running up a huge deficit.

No. 3 is the bond market. The US 10-year Treasury is sitting near 2.5% and remains well bought in the market. This is helping boost the housing market since this is the benchmark for mortgage rates. A strong housing market helps a lot of US sectors.

And with lower Treasury yields, corporate and municipal bonds look even more attractive for the same bond investors. Low yields also reduce funding costs for corporations, which helps the economy and the general stock market.

Last but not least, No. 4 is the US dollar. The dollar, as measured by the Bloomberg US Dollar Index, is up nearly 7% over the past year. That makes the US a prime destination for global investment.

All of these have been underlying themes that I’ve been writing about for the last year and remain bullish on.

The Big Worry

Where will the cracks show up?

The biggest risk for the US stock market is the reality of company performance. One of the reasons for the selloff in the fourth quarter last year was the fear that sales growth and earnings growth would slow in 2019.

This is particularly threatening for the information technology sector. This segment of the S&P 500 has been a big driver in the performance of the index this year. Any disappointments in first quarter earnings this year will most likely hurt the S&P 500, the Nasdaq 100 and the market.

So, while many companies turned in some nice numbers last year, the risk is that as earnings roll in, and slow growth becomes a reality, the selling could come back.

This is why I continue to recommend plenty of income and defensive investments in the model portfolios of Profitable Investing.

With that being said, in most market downturns, there are select stocks and industries that will continue to grow and thrive. I’m already holding plenty of them. But above all else—keep your focus on the dividend- and income-paying investments right now.