Forget Banks and Worry About High Stock Prices

It’s time for investors to stop fighting the last war. The next downturn most likely won’t be triggered by another meltdown of the financial system.

The Federal Reserve has concluded its stress test of big banks, a look into whether they have enough money set aside to withstand another 2008-type financial crisis. The Fed announced last week that all 35 banks examined are sufficiently capitalized. It disclosedthe second and final round of results on Thursday afternoon, giving all but one bank a passing grade and the go-ahead to return money to shareholders.

Investors didn’t need the Fed to tell them that banks are in better shape than they were a decade ago. The signs are everywhere. Profits have fallen across the industry since the financial crisis, an indication that banks are taking on less risk. Profit margins for the S&P 500 Financials Index averaged 9.3 percent from 2008 to 2017, down from an average of 13.8 percent from 2003 to 2007, the years leading up to the crisis. Return on equity is down to an average of 5.2 percent from 14.5 percent over the same periods.

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Stock Buyers Lose Bond Foundation for Steep Valuations

Apologists for high U.S. stock prices just lost their favorite defense.

Ten-year Treasury yields rose above 3 percent on Tuesday for the first time since 2014, and bond investors are hysterical. Chris Verrone, head of technical analysis at Strategas Research Partners, told Bloomberg Television on Monday that breaching 3 percent would ring in “a 35-year trend change in bonds” in which investors in long-term bonds would stop making money.

Let’s take a breath. For one thing, no one knows where interest rates are headed. Moreover, bond investors need not fear rising rates. Yes, bond prices decline when interest rates rise, but higher rates also mean higher yields on new bonds. Over time, those higher yields should more than offset lower prices.

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Users Built Facebook’s Empire, and They Can Crumble It

Facebook’s true value resides in its 2.1 billion users, and investors need to worry about what happens if enough of them decide that free social media isn’t worth the cost.

First,  a disclosure: I’ve never used Facebook. I get that it’s an awesome way to keep in touch with family and friends, meet new people and get a personalized online experience. But I value my privacy, and it’s hard to reconcile that with the fact that Facebook is in the business of selling its users’ information.

And it’s a great business. Facebook generated earnings from continuing operations of $15.9 billion in 2017 on revenue of $40.7 billion, 98 percent of which came from advertising.

If it isn’t already obvious that Facebook is a money-making dynamo, consider how it stacks up with digital ad rival Alphabet Inc., the parent of Google. Facebook’s gross margin was 87 percent last year, and its net income margin was 39 percent. That compares with 59 percent and 11 percent, respectively, for Alphabet.

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High Times for Marijuana Stocks

Marijuana stocks would be the ultimate growth play if investors weren’t already so fired up.

It just got easier for U.S. investors to bet on pot’s big plans. Toronto-based Cronos Group Inc., which invests in medical marijuana producers, on Tuesday became the first marijuana company listed on a major U.S. exchange. Analysts expect its revenue to reach $34 million this year, up from $400,000 in 2016.

Cronos’s debut follows that of ETFMG Alternative Harvest ETF on Dec. 26, the first U.S.-listed marijuana exchange-traded fund. If ETFMG’s popularity is any indication, Cronos will soon be awash with money. Investors have already poured $386 million into the ETF through Tuesday.

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Stock Stumble Isn’t a Starting Gun for Hysteria

Panicking is never a good plan when it comes to investing, but it’s particularly silly now, because nothing truly eventful has happened yet.

Sure, the Dow Jones Industrial Average was down 1,175 points on Monday — the biggest one-day drop ever, before stocks fluctuated on Tuesday. In percentage terms, it was a 4.6 percent decline. Investors may not see that every day, especially recently, but it’s happened plenty of times in the past.

And yes, the S&P 500 Index was down 7.8 percent since Jan. 26 through Monday. But it’s nowhere near a 20 percent decline that constitutes a technical bear market. It’s not yet even a correction, which is a 10 percent decline.

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Slumbering Bear Holds a Lot of Answers

It has been almost nine years since the last U.S. bear market, as defined by a 20 percent or more decline in the S&P 500 Index. That’s the second-longest stretch without one since 1928, according to Yardeni Research Inc. Only the period from December 1987 to March 2000 was longer.

That’s a long time for questions to pile up that can only be answered by the next downturn. Here are some of the most burning ones:

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Not Everything Is Expensive If You Know Where to Look

Investors love to complain that asset prices are too high, but they have only themselves to blame.

Investors bid up the S&P 500’s price-to-earnings ratio to 26.8 at the end of 2017 from 11.1 when the 2008 financial crisis eased in February 2009, based on 10-year trailing average positive earnings from continuing operations.

They drove down yields on the Bloomberg Barclays US Corporate High Yield Bond Index to 5.6 percent at the end of 2017 from 16.1 percent in July 2009. They squashed the yield on the Bloomberg Barclays US Corporate Bond Index to just 2.7 percent from 7.2 percent in May 2009. And they did the same to real estate. The FTSE Nareit U.S. All REITs Index yielded 4.1 percent as of November, down from 11.1 percent in February 2009.

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Still Bullish After All These Years

Jeremy Siegel has never lacked enthusiasm for the market.

Even nine years into one of the strongest stock market recoveries in history, “this bull market is not over yet,” said Siegel, who has been a University of Pennsylvania finance professor since 1976.

That should not come as a surprise. His 1994 book, “Stocks for the Long Run,” helped cement the conventional wisdom that stocks are a better bet for long-term investors than other popular investments such as bonds and gold.

Siegel’s timing couldn’t have been better. A year after his book appeared, U.S. stocks went on an epic run. The S&P 500 Index more than tripled from 1995 to 1999.

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The Ghost of Markets Past

The stock market is at a record high. Investors are chasing a handful of hot stocks. Geopolitical tensions threaten to upend the rally.

I’m referring, of course, to 1972. The S&P 500 Index closed at a record high of 119.12 on Dec. 11. It was the height of the Nifty Fifty (not to be confused with the Nifty 50 Index of India stocks), the idea that investors needed only to buy 50 of the most popular growth stocks and hold them forever.

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Calm Markets Are No Reason to Bid Up Stocks

Low volatility is great, but it doesn’t mean investors should pay more for stocks.

It’s been an unusually quiet time for U.S. equity markets. Stock watchers’ favorite barometer of volatility, the CBOE Volatility Index, or VIX, has averaged just 11.1 so far in 2017 through Monday, making it the calmest year on record. (The lower the VIX, the lower the volatility, and vice versa.) The gauge has averaged 19.4 since its inception in 1990.

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