Why you need to be aware of this hidden change in the markets
From Dr. David Eifrig, MD, MBA:
For years now, it has been hard to pick the wrong stock.
Thanks to a growing economy and loose monetary policy, the vast majority of stocks rose all together as one. Trying to find which ones were the best didn’t pay big rewards since so many stocks soared.
You could measure this by calculating “dispersion.” You look at the best- and worst-performing stocks, and you see how closely the two are related.
As you can see in the following chart, dispersion has been very low, but it’s just now starting to tick up…
Dispersion can seem like an abstract concept to many investors. To understand what it means to you, think about being a real-estate investor…
If you’re a real-estate investor in San Francisco, you’ve made a bundle. No matter what you bought, high-quality or low, property prices have soared. Meanwhile, if you’re an investor in Detroit, it doesn’t matter how smart you are. You’ve likely lost money as property prices plunged. Both of these cities have a low dispersion between the best and worst properties.
But picture a normal city with no overarching macroeconomic trends driving it. You have to know the good from the bad. Any number of methods can help. You can know the city and scoop up properties in improving neighborhoods. You can wait patiently for short sales and foreclosures. You could buy one type of property – say, industrial – and redevelop it to be residential to unlock its value.
That’s a situation with higher dispersion. And it means you can find opportunity. But you can also get stuck with duds.
According to research from Standard & Poor’s, the dispersion of stocks within the benchmark S&P 500 Index has stayed around 5% since the financial crisis. The current rating is 6.4%. That doesn’t sound like a large jump, but it’s on the high end of the “normal” zone.
Our calculations show the same thing. The numbers are a little different from Standard & Poor’s. It uses a market-cap weighting that emphasizes larger stocks, while we weigh the stocks evenly. You can see dispersion is low, but trending upward…
That’s just one data point… a small start to a trend. We see six factors that will separate good businesses from bad in the coming months…
1. Interest rates are set to rise. Low interest rates were one factor pushing all stocks higher. Rising interest rates will separate corporate borrowers – whose costs will rise – from lenders that will earn higher rates of return.
2. The dollar will get stronger. Rising rates should cause the dollar to strengthen against other currencies. This makes it cheaper for American companies to buy foreign goods, but harder to sell goods to foreign markets.
3. Commodities are collapsing. Cheap oil hurts producers and helps consumers. We’ll see those stocks diverge.
4. The short-term credit cycle is peaking. Every three to five years, lenders start to tighten credit standards after a binge of borrowing. Companies that can pay their interest will do fine. Those that are over-indebted will struggle.
5. It’s cheaper than ever to do business. Improving technology makes it easy to do business, design and manufacture goods, and market them to a wide audience. Some companies use this to improve profit margins and generate high levels of free cash flow. For others, this means it’s easier for competitors to join in and erode profit margins.
6. An increase in “indexing.” In 2000, investors had $26 billion in index funds. In 2014, that had grown to $148 billion. More investors are switching to index funds. That’s a smart move. Plus, fewer active market participants could mean finding opportunities will get easier.
We still think investors can make plenty of gains in the stock market. Corporate profit margins are at an all-time high. The valuation of stocks is still reasonable at 17 times future earnings.
This dispersion outlook doesn’t sound like the biggest news in the market. You won’t turn any heads at cocktail parties when you bring up dispersion.
But this subtle shift could be very big news for your total wealth.
For one, you need to keep a closer eye on your investments to avoid dogs. And you can earn bigger rewards by sticking to quality names from here on out.
Here’s to our health, wealth, and a great retirement,
Dr. David Eifrig
P.S. No one can know the future, but I wouldn’t be surprised if the broad markets are sideways in 2016, if not slightly down for the year. In my Retirement Trader newsletter, I told my subscribers a defensive strategy to protect us from a sideways or down-turning market.
If you’re not a Retirement Trader subscriber, next week I’ll be discussing our in-depth strategy… with the intent of showing folks how to make an extra $1,000 a month through all of 2016. If you’re interested, sign up for this special live presentation here (It’s completely free).