It seems like our little “correction” appears to be over. The stock market indexes are all at or near all-time highs. Investors continue to remain comfortable with the “goldilocks” environment (not too hot, not too cold) for stocks: rising earnings, low inflation and reduced fears over Federal Reserve policies. The situation in Syria? De-fused for now. Debt ceiling debate? It may get ugly for a while, but ultimately there will be a resolution to the debt ceiling.
Of greater concern of late is Twitter and rising “animal spirits.” “New age” Internet stocks, like Zillow, Netflix and Facebook, have been on a tear lately, some of them up by over 200 percent in the last year. On top of this, Twitter, a social media company, recently announced it will go public. Why now? Twitter and its bankers sense the market is ready for it. The “animal spirits” of the market are ready and salivating for the next quick flip IPO.
Traditionally, when we talk about animal spirits, it refers to the human propensity for taking on more risk when things “look good,” when the market’s been up, and, oh yes, when it now seems OK to take on more risk. That smacks of overconfidence, and overconfidence is a problem for the stock market.
While we suspect there is more upside for the stock market in the near term, the rising animal spirits may be an early warning sign that the market is no longer “cheap” and that market “risk,” or volatility, may be increasing. From a financial planning perspective, the best way to protect retirement and investment portfolios from volatility is through appropriate asset allocation and diversification. Holding multiple asset classes in a portfolio reduces risk because different asset classes typically behave differently in different parts of a cycle (for example, bond prices usually go up when stocks go down). Sticking to a long-term financial and investment plan also lowers risk by reducing the temptation to “time” the market and buy or sell at the worst possible time in the cycle.
Bob Toomey is Vice President, Research, for S.R. Schill & Associates, a registered investment advisor located on Mercer Island.