We are approaching the end of 2014 with the markets at/near a record high. The market’s recovery since March of 2009 has now lasted nearly 5 years with only a few pullbacks. There has been some concern about the market’s rise as headlines bring reasons for concern. The American middle class does not seem to be benefitting from the less-than-robust economic recovery. The labor force participation rate has hit a 35 year low. Add to that a record national debt now over $18 trillion, unrest both here and abroad; there are a lot of things to worry about.
That is all true, but stocks are driven by corporate profits and profits are rising.
It’s too easy to get distracted by “noise.” While the issues that get the headlines are important, they may have little or no impact on the price of any one stock or the direction of the market. And in the investment business, that’s what counts.
There is one issue that can create a problem for many investors. It’s the issue of “indexing” and relative performance. The S&P 500 index is the primary benchmark for many investors and portfolio managers. However, it can create a self-fulfilling prophesy because it is market weighted. That means that all 500 stocks are not treated equally. The larger the company, the more impact it has on the index. Consider that the 20 largest stocks in the S&P 500 are just 4% of the stocks in the index but about 30% of the weight of the index. That means that just a few stocks have an outsized influence on the index.
That’s fine when the price of these large companies go up. But when they begin to go down, people have the impression that all stocks are going down. This is not true. But since indexing has become so popular, the passive investors in the index funds will experience a great deal of financial pain if and when these over-valued stocks come back down to earth.