US equity markets - Beware the FOMO

The U.S. equity markets have attracted a lot of interest in recent months as the economic recovery takes shape (i.e., V-shaped recovery) and even accelerates. Indeed, the equity markets have had a tremendous run since their COVID-19 meltdown in March 2020 which resulted in the major U.S. indices falling about 30%. The S&P, DOW & NASDAQ indices have all rebounded strongly and sharply, notching gains of 84%, 81% & 102%, respectively. Consequently, investors who got in at the right time would have made significant returns in a relatively short period of time, causing those who have missed out so far to hope that the “good times” will continue on the back of vaccine rollouts and monetary and fiscal stimuli. Investors should however approach these equity markets with caution.

While favourable policy tailwinds are a pillar of the positive fundamental outlook, the path ahead for U.S. equity markets is beset with uncertainty as fiscal stimuli will continue to stoke bouts of anxiety over higher inflation, rising interest rates, and potentially less support from the U.S. Central Bank (Fed). That anxiety is likely to show up in periodic pullbacks in the equity markets. Additionally, owing to strong market gains last year and year-to-date 2021, equity valuations appear to be stretched and already discount a lot of the positive news.

Questions about overvaluation and what appears to be at times exuberance in trading, have sparked tremendous volatility in U.S. equity markets this year so far. The recent Game-Stop and AMC phenomena are apt reminders of how the fear of missing out (FOMO) can quickly turn perceived opportunity into misfortune. FOMO seduced many investors to buy into these stocks which were undergoing hyperbolic increases in their prices which subsequently tumbled as fast as they rose. While some investors who bought and sold early during the trading frenzy profited, many who were late to the “party” experienced severe losses. So, be reminded that while investing in stocks can deliver outsized returns in a relatively short of period, it can also produce significant losses. 

Stocks should be viewed as long-term investments, that is, funds that will not be needed for at least five years. Other considerations when deciding to invest in stocks include the following:

• Companies are not obligated to make dividend payments to investors and so stocks cannot be relied upon for regular and predictable income, unlike bonds.
• Payment of any dividends will attract withholding taxes unlike interest payments on bonds which are usually paid out gross.
• For non-dividend paying stocks, an investor requires the stock price to appreciate over time to earn a positive return on investment.
• The historical return on the U.S. stock market (S&P 500) has been around 10%, so the higher the recent returns in the stock market, the lower the future returns are expected to be.

While there is a place for stocks in an investment portfolio and the U.S. equity markets may continue to do well, one should not get carried away and commit too much of one’s portfolio into stocks. As a rule of thumb, an investor should limit concentration to risky assets (such as stocks) to a proportion equivalent to 100 minus their age. Hence, the older an investor the smaller the percentage allocated to stocks should be. It is also a useful reminder that investing in bonds can also produce returns comparable to stocks and often the returns on bonds outpace those on stocks. As an example, the compound annual growth rate (CAGR) of the S&P 500 over the last 5 years has been about 6% (source: Bloomberg data), while the return of a bond mutual fund that has been in existence for about the same period has produced a whopping CAGR of approximately 12%.

As always, before investing, consult with your financial practitioner to determine if the potential investment is suitable for you.

Eugene Stanley is the VP, Fixed Income & Foreign Exchange at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual, and institutional investor. Visit our website at www.sterling.com.jm Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm