With NYSE President Lynn Martin at the helm, the future of the US stock market looks brighter than ever. Fresh off a record year of new listings, the exchange is positioned for a future in which every company is a technology company. However, many investors are unsure about how to best invest in the US stock market.
Bonds
The future of the US stock market and bonds is largely in the hands of investors. Stocks provide a regular and stable stream of income, and bonds provide a safe haven. Treasury bonds, for instance, pay investors biannual interest payments. Many people choose to hold bonds as part of their portfolio for retirement, their children’s education, and other long-term needs. This type of investment is not without risk.
The United States equity market is currently overvalued, and analysts are not expecting much improvement over the next few years. However, earnings growth is expected to remain solid in the medium term. While growth rates have slowed a bit over the last year, analysts do not expect them to decline much. That means that stock prices have already priced in lower earnings expectations. While stock prices have historically provided investors with higher expected returns than bonds, they also come with higher risks.
Corporate profits
After a rocky start to the year, corporate profits are showing signs of an upward trend. Many investors had been bracing for an even worse outlook this earnings season. Yet, as of the end of the second quarter, corporate profits jumped 8.1% over the same period last year. This is above the long-term average and is a welcome sign for investors.
Corporate profits are a good leading indicator of the stock market, but when they start to decline, businesses are likely to reduce spending or cut back on investment, which will cause stock valuations to drop. However, companies often begin cutting costs and deferring investments long before the stock market deteriorates. The first quarter of 2016 was the fourth consecutive quarter in which corporate profits declined.
Volatility
While it is difficult to ignore fluctuations in stock prices, investors should know that volatility is not uncommon in markets. Volatility is a temporary stage of the market and is often an opportunity to buy strong stocks at a cheap price. Investors should always adjust their time horizons and financial goals accordingly.
Volatility in the market occurs due to a number of factors. It can be caused by stock market gains, or by uncertainty. Some traders believe that this volatility is temporary, while others say it is permanent. The Federal Reserve System, or the central banking system in the United States, controls the country’s monetary system. Volatility increases when the economy releases unexpected economic data that differ from expectations. A sudden change in interest rates can also cause volatility.
Dollar-cost averaging
Dollar-cost averaging can be a practical alternative to investing large sums of money in the stock market. It is a method of investing where an investor invests the same amount of money in the same stock five times in five consecutive months. The method assumes that the price of the stock will decline after the initial trade, so the average price will be lower than the initial price. This method can help investors avoid emotional risks by removing them from the process of capital allocation. Especially for new investors, dollar-cost averaging can be a valuable investment strategy. It can even help those who buy baskets of securities or index funds.
Another benefit of dollar-cost averaging is that it can be effective even in a sideways market. Buying stocks at different prices can help investors take advantage of dips in the price. Using dollar-cost averaging, an investor can purchase shares at varying prices over time, thereby reducing their average cost per share.
Fed rate hikes
Interest rates are a big part of the stock market’s overall value, and a change in the rate can have widespread economic effects. While a rate hike can affect all markets, the stock market often reacts in a more immediate fashion. Investors price in future rate hikes and anticipate what the FOMC will do. Learning more about this relationship can help you make better financial decisions.
The Fed is likely to raise its benchmark interest rate once again this year, bringing it up to four percent. While this doesn’t directly affect mortgage rates, it does have an impact on how much banks pay for borrowing money, which helps drive the pricing of loans. The rate hikes are a critical part of shaping financial conditions, and the Fed’s communication is critical to getting markets to price in future increases.
Financial sector earnings
Investors should look to the financial sector for long-term growth. For the past 30 years, the S&P 500’s financial sector earnings have grown at a compound annual growth rate of more than 6%, almost twice the rate of GDP, after dividends. Financial companies that are managed well are often able to take share from competitors and maintain impressive growth rates for decades. Often investors overlook this aspect of a mature industry.
Big banks are kicking off the third-quarter earnings season this week. These earnings announcements are historically a major driver of broader market performance. The energy sector is also expected to play an outsized role in third-quarter profit growth. Consumer spending is still strong, although the impact of higher borrowing costs on consumer spending will be felt.
