Mario Kart and the Markets
The purpose of any race is to cross the finish line first. Yet, in the virtual race that is Mario Kart, it’s easy for emotion to derail strategy. You can find yourself totally obsessed with settling scores – avenging the last onslaught of turtle shells or infuriating bananas. You see the distraction coming, yet somehow you hit it anyway. If you played Mario Kart to win, you would ignore the pestering of other players, focus on your driving, and not waste precious time collecting power-ups. But where’s the fun in that??
The investment world offers similar drama and distractions which tempt us to take our focus away from the real long-term objectives of our investments. As an example, last summer it rained “bananas” in the global markets. A partial list:
China unexpectedly devalued its currency, the renminbi (RMB).
Stocks crashed, with the Dow plunging by more than 1,000 points in a single day.
The Federal Reserve announced it would delay rate hikes.
Volkswagen confessed to using software to cheat emissions-standards tests.
September's US payrolls report was a flop.
Other news headlines, including the risk of a US government shutdown and Russia's intervention in Syria.
Yet, in spite of the gut wrenching roller coaster the financial world has been on, global market values are back to nearly the same levels as they were at the start of summer.
Here’s the lesson I take away from the rebound: While psychology may affect the short term, the long term is ruled by economics and valuations.
When I say “valuations” I’m referring to the price of the market in comparison to its historic value. You have probably heard the term “P/E ratio” which is the price per share of stock divided by its earnings per share. The higher the number, the more expensive the stock is. We can also calculate an average all individual stock P/E ratios to determine how expensive the market is as a whole.
The historical average P/E of the market is 16.6, whereas we are currently at a P/E ratio of 22. That may seem expensive based on this historic average, but there have been many economic expansions that have far surpassed this valuation.
This where economics comes into play, and here are a few encouraging signs in the U.S.:
Hiring has accelerated, with unemployment below 5%.
Prolonged steady economic growth.
Higher interest rates will boost foreign investment.
Low oil prices will boost consumer spending.
Cheap natural gas will encourage insourcing due to lower costs of energy production.
The U.S. Energy Information Administration expects us to be a net exporter of natural gas in 2017 and a net exporter of all energy by 2028.
Regarding that last point, “This reflects changes in both supply and demand, as continued growth in oil and natural gas production and the use of renewables combine with demand-side efficiencies to moderate demand growth. The United States has been a net importer of energy since the 1950s.”(1)
Thanks to technological advancements in drilling and hydraulic fracturing (fracking) of shale formations, oil and gas production has increased dramatically. The industry’s three-year growth between 2010 and 2013 reached 168%.
The United States has replaced both Saudi Arabia and Russia as the world’s biggest oil producer and surpassed the latter as the world’s largest natural gas producer. The U.S. also has more wind energy powering its grid than any other global nation and is making strides in solar power technology.
The explosion in shale oil production has been instrumental in aiding our nation’s recovery. In 2012, the sector introduced 2.1 million new jobs. Consumer wallets have also been affected, with the average household disposable income increasing by $1,200. Currently, the U.S. invests a record $200 billion in oil and gas and is moving towards reversing the decades-old ban on crude exports.(2)
Though the recent drop in oil prices has put a dent in oil companies' exploration budgets, on the macro level cheaper oil is likely a net benefit for the economy.
So here’s the takeaway: There’s a lot of drama in the financial world, but very little of it pertains to the big picture. Valuations aren’t in fact high for an expanding economy, and the U.S. looks to be benefiting from the developing energy renaissance. In other words, try not to get caught up in the spectacle and instead focus on the race. That isn’t to say someone won’t power-up and thunderbolt you (i.e. a possible terrorist attack or act of war) but in the long-run things tend to come full circle. After all, there are four races in a circuit.
EIA Staff. "U.S. Energy Imports and Exports to Come into Balance for First Time since 1950s." U.S. Energy Imports and Exports to Come into Balance for First Time since 1950s. U.S. Energy Information Administration, 15 Apr. 2015. Web. 22 Feb. 2016.
Deutsch, Alison L. "The 5 Industries Driving the U.S Economy | Investopedia." Investopedia. N.p., 29 Apr. 2015. Web. 22 Feb. 2016.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. It is unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.