The financial world can be a scary place. It seems like there is always something to fear in the market. This is especially true in 2020 when investors have endured COVID-19, extreme stock market volatility, massive economic uncertainty and now a Presidential election.
Fortunately, our worst fears usually don’t come to fruition. To get in the Halloween spirit we are posting three scary charts that may keep you up at night. Stay tuned in the coming weeks for “charts we are thankful for.”

1) Government Debt
Government debt around the world has skyrocketed in recent years. For example, by the end of 2021, the U.S. is on pace to set a new record high debt to GDP ratio, even higher than in the aftermath of World War II. While we do not believe this will result in a fiscal crisis in the next couple of years, a failure to rein in deficits once the economy recovers, could lead to significant problems. In particular, a sharp rise in inflation could result in higher interest rates and higher taxes and could ultimately set the stage for slower future growth.

2) U.S. Stock Market Concentration

Nearly 25% of the S&P 500 Index is comprised of just five stocks – Apple, Microsoft, Amazon, Alphabet and Facebook [1]. This decreases the diversification of the S&P 500 Index and concentrates the risk of the index into a handful of stocks.

In addition, research from Dimensional Fund Advisors shows that five years after becoming one of the 10 largest stocks in the US market, these stocks, on average, underperformed the market by 1.1% annualized. The gap was even wider 10 years out, as they underperformed by 1.5% annualized [2].

3) U.S. Stock Market Valuations
No matter how you measure current valuations in the US stock market, they are high relative to history. By one common measure, the S&P 500 has only been at these valuations two other times: in 1929 and in 2000 [3].
Historically low interest rates and the fact that the most important sectors of the equity market are relatively unaffected by the social distancing recession may justify a portion of the high valuations. That being said, the economic and investment outlook is unusually uncertain right now and some correction in stock prices is quite possible based on current valuations.

Happy Halloween!

[1] Source: Charles Schwab, quarterly chartbook Q4 2020. As of 9/30/2020

[2] Dimension Fund Advisors, “Why Investors Might Think Twice About Chasing the Biggest Stocks”. Returns are measured as of start of first calendar year after a stock joined the top 10.

[3] Source: multpl.com, as of 10/27/2020. Price earnings ratio is based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted PE Ratio (CAPE Ratio), Shiller PE Ratio, or PE 10.

IMPORTANT DISCLOSURES
Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).
This newsletter is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced herein is historical in nature and is not an indication of or a guarantee of future results. All indices are 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.

Your experience may vary according to your individual circumstances and there can be no assurance that LRIA will be able to achieve similar results for all clients in comparable situations or that any strategy or investment will prove profitable. As investment returns, inflation, taxes and other economic conditions vary, your actual results may vary significantly. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility, therefore.

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Index Definitions

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 cannot be invested into directly.