As the financial markets continue to roar with boundless optimism, a look back 30 years ago to a similar bull run paints a much more sobering view.
1987 had been a strong year for the stock market, as it continued the bull market that began in 1982. However, there were some warning signs. There was geopolitical issues related to currency disputes between the United States and Germany. The strong dollar was putting pressure on U.S. exports. Valuation for the stock market had climbed to excessive levels. Rising markets had even prudent portfolio managers who were skeptical of the market advance finding themselves being forced to buy at elevated levels. With no Dodd-Frank or Volker Rule or any other regulatory rules to limit risk, institutions relied on program trading to protect themselves from market weakness. The belief was that it would handle all concerns related to risk management. Eventually, all these variables coalesced to create one of the worst days for the stock market on Oct. 19, 1987.
One could be using the same sentences to describe the current bull market. Geopolitical issues, strong dollar, high valuations, frenzied buying and prospect of easing in regulations. But, one key difference in the current conditions to those seen 1987 is that current economic data reflects strength, not just in the US economy, but globally as well, while in early 1987, economic growth was slowing when inflation was rearing its head. The question is – Will economic strength be enough to sustain the market from a similar correction?
Future Wealth’s View
In portfolio theory, there are two key types of risks – systematic and unsystematic risks. Unsystematic risks refers to specific risks related to a company stock and that could be a new competitor, a regulatory change, a management change or a product recall etc. Systematic risk, also known as market risk, is the uncertainty inherent to the entire market. Interest rates, terrorism, recession and wars, all represent sources of systematic risk.
Unsystematic risks can be reduced through diversification by owning stocks in different companies and in different industries, as well as by owning other types of securities such as Treasuries and Municipal securities or other asset classes. Systematic risks cannot be diversified and is by far the biggest challenge facing every investor today. Trump’s ability to execute tax reform, replace Obamacare, get Congress to pass an infrastructure spending bill, bring jobs back to America are all systematic risks and the outcome of these priorities will decide if the market continues to move higher or not.
Shameless Pitch – At Future Wealth, we use tools to mitigate both systematic and unsystematic risks.
But, for all the backlash he has received, President Trump does deserve an award for reigniting a market that looked already primed for a correction late last year. Speaking of awards, the “Einstein” from PWC who gave the wrong envelope, should be happy that Oscars are held in the US and not in North Korea. He would have been put in front of another specially invited audience much like the Oscars, along with the five others who gave false reports to Kim Jong Un, and would have been executed by anti-aircraft guns.