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Peter Morici: Investing in a scorching market

A man monitors stock prices at a brokerage house in Beijing, Monday, Oct. 30, 2017.
A man monitors stock prices at a brokerage house in Beijing, Monday, Oct. 30, 2017.
Andy Wong, AP

Stocks have just accomplished a Houdini — scorching to record highs while escaping volatility. The S&P 500, which accounts for 80 percent of the value of publicly traded U.S. companies, just scored an unprecedented 14 consecutive monthly gains.

Investment professionals will tell ordinary folks a year like 2017 simply can’t repeat. Gains will slow or the market will tank, volatility has to increase and with the Federal Reserve raising interest rates, they should diversify into bonds. And of course, hire one of them to manage it all.

Ignore that advice.

Stocks remain cheap — the average price-earnings ratio for the S&P 500 is 22. Those are well below their 25-year average.

The forces pushing up valuations remain prescient. With tax cuts boosting consumer spending and business investment, the U.S. economy is poised for another good year, and the outlook for corporate profits growth remains robust.

Last year, the Federal Reserve pushed up the overnight bank rate by 0.75 percent — the same increase expected this year — but the 10-year Treasury rate was largely unchanged and mortgage rates fell.

Simply, European and Japanese central bankers are reluctant to push up their interest rates, and when the Fed tightens and U.S. long rates try to rise, foreign money seeking yield rushes in to push those back down.

Moreover rotating from stocks to bonds comes down to trying to time the market. I don’t know anyone who can do that.

In 2012, retail investors pulled $1 trillion from managed mutual funds and most of that was not otherwise reinvested in the market. Since that time, the S&P 500 has more than doubled.

If you are among those who sold out and thought you could pick the next good buying opportunity, you missed one of the great bull markets of all time.

Repent. Buy back in with a fixed schedule of monthly stock purchases.

A lot of the stock market gains have been significantly concentrated among tech stocks that have registered big gains in sales and profits — in particular Apple, Facebook and several others — but performance across sectors tends to average out over time.

Investment professionals will say those adjustments will breed volatility and offer opportunities for mutual funds managers and wealth advisers to pick the next round of winners. Economists and Warren Buffett — probably the greatest stock picker of all time — eschew that advice for a simple reason — the long-term track record of most fund managers is lousy.

Many readers will receive advertisements that specific managed funds beat the market in recent years, but an examination of the recent record of the best portfolio managers five years ago verifies that most would be hard pressed to make the same claim today.

Every Sunday, a few bettors at the track get lucky — each picks a couple of long shots and wins big. Take their tips the rest of the week, and you end up poor by Saturday.

Ordinary investors should put their retirement nest egg and most of their savings in a broad index fund — such as the USAA fund that tracks the S&P 500. And perhaps stash 20 percent of their stock allocation into an international index fund to smooth returns — sometimes U.S. equities do better, while other times foreign stocks lead.

How much folks nearing retirement should put into bonds or other fixed income investments depends on how large their holdings are relative to their expected annual cash needs. For most retirees, 50 percent stocks and 50 percent bonds is a good benchmark. Gradually start moving toward that allocation 10 years prior to your target retirement date.

Remember, the market values of bonds with distant maturity dates fall as interest rates rise. Hence, it’s best to build a ladder of Treasuries, CDs and high-grade tax-free state and municipal bonds that will mature as you need funds.

Younger folks should just gradually buy into the market with each paycheck. Payroll deductions for IRAs and such are best, as that strategy takes away the temptation to try to outsmart the market by timing your purchases to exploit market ups and downs.

When I meet someone who can really beat the market, I will surely write a glowing column about him or her. In the meantime, I will go to my inventor’s basement and resume work on my perpetual motion machine.