What to do when Even the Experts are Perplexed

January 25, 2021

My Dear Reader,

As the market sits at roughly 31 thousand points, it would appear as though the Dow is stagnant when compared to the gains of the Trump administration. However, as noted by Steve Goldstein, during the past twelve weeks, the stock market has seen one of the greatest inflows to stocks according to Bank of America. This has puzzled many experts, as Goldstein notes in his article on Market Watch:

“As the chart shows, spikes in margin debt often precede major stock-market busts. The good news — for those invested in the market — is that stock market leverage is an accelerator. “When stocks already rise, and investors feel confident, they borrow money to buy more stocks, and they can borrow more against their stocks because their value has risen. And this additional borrowed money is then chasing after stocks and thereby creating more buying pressure, and prices surge further,” Richter writes. And the inevitable bad news: “Stock market leverage is an accelerator on the way down when stock prices are already falling and brokers issue margin calls to their clients that then have to sell stocks to remain compliant, triggering a bout of forced selling, and many leveraged investors sell ahead of margin calls in order to avoid being forced into selling at the worst possible moment.”

While leverage for any financial investment is the axis on which wealth moves, a common killer in a down market occurs when large companies “over-leverage” and during a correction, a financial institution calls the margins.  This is why a small contraction in one market sector can cause a major financial crisis across the board, and right now, it would appear that we are in a precarious position.  Market speculation has hit an all-time high, and with 401ks and IRAs becoming more and more ubiquitous; the amount of Americans invested in the market and who use the market as the base for their financial plan has only grown, which could multiply the devastation.  In addition, old stalwarts such as bonds and even bank CDs have seen returns that hardly clear the inflation rate, which naturally increases the amount of risk that portfolio managers are going to have to take, even in the most conservative funds in order to churn out a respectable rate of return.  Or funds could invest in larger companies with higher starting prices, which can contribute to lower returns because of the high entry fee.  

While some have predicted a major crash in the next 24 months, others have boasted that there will be a continuing boon for the next 24, and the only clarity that we can glean from either side is that no one is exactly sure of what to make in the market.  As for answers, I can only say that the solution to me is to not base our financial plans on the market.  If we instead make modest gains outside the market, we can then leverage into the market during a correction to maximize an otherwise worrisome situation.  Real assets such as real estate or precious metals could also help us make nice gains in a fluctuating market.

To your creation and potential,

Kevin Prendiville