Dollar-Cost Averaging – An Alternative to “Jumping” Back Into the Market
In the last few weeks, I’ve been suggesting that it is not time to jump back into the stock market with both feet due to the market’s overvaluation; but that continuing a program of gradually building an investment portfolio is appropriate. This brings to mind an investment strategy known as Dollar-Cost Averaging.
When pursuing a dollar-cost averaging strategy, an investor puts equal amounts of money into the stock market at intervals, usually evenly spaced, over some period of time; e.g., weekly, monthly, or quarterly. This strategy is designed to average out the volatility of the stock market. It is also designed to avoid the very costly mistake of putting a large sum of money in the market at a time when the market may be priced too high and could possibly suffer a downturn.
One mechanism of the strategy is that fewer shares are bought at high prices and more shares are bought at lower prices, thus leading to a lower average cost basis. The dollar-cost averaging strategy operates under the assumption that the stock market will rise in price over time. If that is the case, investors will often get a lower cost basis over time. If the market persistently declines, dollar-cost averaging doesn’t work as well. But the markets have historically risen over time and the expectation is that will continue to be the case in the future.
Dollar-cost averaging is a long-term strategy. This strategy is better suited for investing in the stock market as a whole, as opposed to investing in individual stocks. Although, strategies that invest in individual stocks, such as dividend reinvestment plans, are essentially dollar-cost averaging approaches. It should be noted that there is some criticism of the dollar-cost averaging approach and some studies have shown that investing a lump sum in the stock market may lead to better returns. But two of the significant advantages of dollar-cost averaging are that: (1) it may get people investing back into the market after a significant decline in the market when investors are generally fearful; and (2) dollar-cost averaging entails a commitment on the part of investors to start a regular savings program that invests in the stock market. It is for these latter two reasons, in particular, that we are strong proponents of the strategy.
Economic and Investment Highlights
Last Week
Factory furloughs across the U.S. economy are becoming permanent instead of temporary.
Tesla resumed production, defying orders by local authorities to remain closed.
Many policy makers and company executives now expect a very slow recovery.
Hotels are beginning to reopen and global occupancy rates are leveling off according the Marriott’s CEO.
House-rental companies appear to be weathering the economic crisis well and their stock prices have been reflecting this situation.
April consumer prices declined 0.8%, the most since the last recession.
Public pension plans lost a median 13.2% in the quarter ending in March, the worst quarterly performance on record.
U.S. health officials again warned of the risks of reopening too early and said that expanded testing was critical as the country begins to reopen.
The U.S. budget deficit increased to a record $1.935 trillion in the twelve months that ended in April.
Fed Chairman Powell said further stimulus may be needed to support the economy.
In a Wall Street Journal survey of economic forecasters, the forecasters expect the unemployment rate to rise to 17% by June.
Tax breaks totaling an estimated $650 billion have started to flow to businesses.
New unemployment claims totaled three million last week.
Japan began significantly easing coronavirus restrictions.
The coronavirus has accelerated the ongoing shakeout in the retailing sector.
Consumers cut back on spending in April at the fastest pace in decades. Retail sales fell 16.4%.
Factories also cut output in April at the fastest pace in decades. Manufacturing output fell 13.7%.
China’s economy showed some signs of recovery in April as the country began returning to work. Joblessness and consumer spending remained impacted.
Germany’s economy contracted into a recession in the first quarter.
J.C. Penney filed for Chapter 11 bankruptcy protection.
The Dow, the S&P 500, and the Nasdaq all fell for the week. The Dow was down 2.7%; the S&P 500 was down 2.26%; and the Nasdaq was down 1.2%. The 10-year treasury yield ended the week at 0.640%. Gold closed at $1,753.40 for the week. Oil closed at $29.43 for the week.
The Week Ahead
This link takes you to Econoday’s Economic Calendar and Economic Events and Analysis which shows the upcoming economic reporting events scheduled in the week and months ahead.
Summary
Note: The models below may not capture the impact of COVID-19 beyond their impact on GDP source data and relevant economic reports that have already been released. They may not anticipate the impact of COVID-19 on forthcoming economic reports beyond the standard internal dynamics of the models.
Note: The comments that follow are derived from the economic indicators referenced in the Resources section of this newsletter and other sources in this report.
The Aruoba-Diebold-Scotti Business Conditions Index (ALS) had been trending up for several weeks from having dipped in 2019. Recently with the advent of the economic collapse, the index crashed. This is an extremely negative indicator for the economy on a short-term basis.
The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2020 is -42.8 percent. This reading continues to support the ALS model assessment of a deteriorating short-term economic environment.
The New York Fed Staff Nowcast stands at -31.1% for 2020:Q2.
The Chicago Fed National Activity Index (CFNAI) showed a decrease in economic activity in March. The Chicago Fed National Activity Index (CFNAI) was -4.19 in March, down from +0.06 in February.
All told, these short-term economic indicators are a negative analysis for the economy, at least on a short-term basis.
Expectations that stock prices will rise over the next six months is now at 23.3% in a recent AAII Sentiment Survey. The historical average is 38.0% for the survey. 26.1% of the investors in the survey described their short-term outlook as neutral and 50.6% were bearish. Please see the AAII Sentiment Survey for the complete results.
The latest Gross Output (GO) reading (April 6, 2020) showed that Gross Output slowed significantly in the fourth quarter of 2019.
On a longer-term basis, the forecasters in the Philadelphia Fed’s Survey of Professional Forecasters (as of May 15, 2020) predict real GDP will contract at an annual rate of -32.2 percent for the second quarter of 2020; and increase at 10.6 percent for the third quarter of 2020, 6.5 percent in the fourth quarter of 2020, 6.8 percent in the first quarter of 2021, and 4.1 percent in the second quarter of 2021. On an annual-average over annual-average basis, the forecasters predict real GDP to contract -5.6 percent in 2020; and grow 3.1 percent in 2021, 4.1 percent in 2022 and 2.2 percent in 2023. The forecasters predict the unemployment rate will be above 10.0 percent over the next three quarters (16.1 percent in Q2, 12.9 percent in Q3, and 11.0 percent in Q4); will be 10.8 percent in 2020; 8.1 percent in 2021, 6.2 percent in 2022, and 5.1 percent in 2023. The next survey release date is August 14, 2020.
The National Association for Business Economics (NABE) released an Outlook Flash Survey on April 10, 2020. The NABE panel expects GDP declines in Q1 2020 and Q2 2020, and upticks in Q3 2020 and Q4 2020. The panel believes the U.S. economy is already in a recession and predicts real GDP will grow at an annual rate of -2.4 percent for the first quarter of 2020, -26.5 percent for the second quarter of 2020, 2.0 percent in the third quarter of 2020, 5.8 percent in the fourth quarter of 2020, and 6.0 percent in the first quarter of 2021. The forecasters expect unemployment to average 3.8% in Q1 2020. The median unemployment rate projection for Q2 2020 is 12.0%. The unemployment rate is expected to fall back to 9.5% at the end of 2020, and to 6.0% at year-end 2021. The panel’s forecast for the PCE price index less food and energy calls for a slowdown in the annual rate of change from 1.7% in Q1 to 0.8% in Q2 2020. The panel expects the rate to increase gradually to 1.7% in the last half of 2021.
For a more in-depth review and analysis of the economy, please see our mini-book on economic analysis and forecasting entitled: Simple and Effective Economic Forecasting.
Stock Market Valuations
Our estimates of the market valuations for two stock market indices, the Dow Jones Industrial Average (DJIA) and the Standard & Poor’s 500 (S&P 500), can be found in the file below:
Conclusion
During this time of global flux due to the coronavirus, I am leaving the Conclusion discussion below the same as was posted on March 23, 2020. The March 23, 2020 discussion still adequately reflects my thinking on the current state of affairs.
Important Note: While I don’t believe it is time to jump back into the stock market in a big way because of the market’s overvaluation, I have been advising the last few of weeks in my weekly podcast, Intrinsic Value Wealth Report Radio, that investors can continue building their investment portfolios by selecting individual securities that offer growth and value opportunities.
Reprinted from March 23, 2020
Up until the past week, the economy had been in a stable but somewhat vulnerable state. Nonetheless, it had remained fairly strong. In fact, robust consumer spending and strong labor market conditions had given us confidence that the economy, which had been in its tenth year of expansion, could continue to grow. But we were cautious on this outlook. There were several reasons for our caution. U.S. business growth had been mixed. And global economic growth had been mixed as well. The new coronavirus was becoming a global economic threat, although it was still too early to tell how much of an effect it would ultimately have. Debt is at high levels for consumers, businesses, and government (at all levels of government). Finally, this is an election year that will likely have significant consequences either positively or negatively depending on the outcome of the elections. And of course, it is still too early to tell what the outcome of the elections will be.
In just a few days, the coronavirus’s effect on the economy and the markets went from a ripple to a tsunami. Businesses are shuttering, events are being cancelled or postponed, grocery store shelves are empty, and people are being asked or ordered to stay home. The markets are now deep in bear market territory. The effects on the economy, even given the short time that the economy has been retreating, may be with us for a long time. There is now a much greater risk of a recession, and there has even been some talk of a depression. The government, the Fed, Republicans, and Democrats, and pretty much the entire country, is trying to get the virus under control and is coming up with plans to mitigate the long-term economic effects caused by the virus. But the virus has impacted the economy – in a significant way – in just a short time. How long lasting the effects will be no one can tell right now. The economy has been largely shut down and remains so today. It takes time to restart the economy after a situation such as what is occurring at the present time.
Given these events and the rapidly deteriorating situation, as I said last week, I would caution not to panic. The economy and the markets will get better. The situation is bad – there is no doubt about that – but it will turn around. The real question is when will it turn around? No one knows that at the present time. But it will turn around.
For now, review your investment portfolios. It is highly likely that all or most of your stocks are down. You should not consider selling the bulk of your stocks – only consider selling companies that are not sound companies. But do recognize that as the economy deteriorates, even good companies will be affected.
For stock market value hunters, we believe it is still too early to jump back in. We will be closely monitoring the markets using the many tools and models that we have developed over the years to assess the economy and the markets. We will use our best judgement and thoughts to let you know when we believe things are turning around. The turnaround hasn’t happened yet.
We believe it is important to maintain a long-term view toward investing. But for now, just sit tight. Eventually, this means that you should continue building your investment portfolio using the Cassandra Stock Selection Model to select individual securities that offer growth and value opportunities.
Chart for Review and Thought
Simple and Effective Economic Forecasting Model
Note: The table and chart below have not been updated. However, we believe that a recession is quite likely. In the chart below, the bottom green line shows what a recession could look like.
Notes (GDP Growth Chart):
- See the July 8, 2019 Commentary for an introduction to this model.
- Actual numbers 2007 through 2019; forecasted numbers thereafter.
- Normal GDP growth is typically in the 2% to 3% range.
- A recession is generally defined as two consecutive quarters of negative economic growth as measured by a country’s gross domestic product (GDP).
Thought for the Week
“It ain’t over till it’s over.” ~ Yogi Berra
Announcements
The Intrinsic Value Wealth Report has started a new YouTube channel called Intrinsic Value Wealth Report TV. You can view the YouTube channel at Intrinsic Value Wealth Report TV.
The Intrinsic Value Wealth Report has started a new podcast called Intrinsic Value Wealth Report Radio. You can listen to the podcast at Intrinsic Value Wealth Report Radio.
Dr. Wendee spoke at the Investment Club of America’s annual economic summit, called Econosummit, on Sunday March 1, 2020 in Las Vegas.
Dr. Wendee attended the The National Due Diligence Alliance (TNDDA) investment banking conference, which was held March 6-8, 2020 at the Four Seasons Resort in Dallas, Texas. This is a conference held several times throughout the year for investment bankers and registered investment advisers to learn about new opportunities in the Alternative Investment asset classes.
We have been researching the use of crowdsourcing for investment ideas. We will be sending a survey out in the next few weeks to get your input on the economy and the markets; and to get any investment ideas that you would like to share. We will compile this input and distribute the results to you and our other subscribers. We have been testing our crowdsourcing models with students and have been having good success and results.
Dr. Wendee has been researching and writing a new theory of economics known as, The Value Creation Theory of the Economy (also known as, Intrinsinomics). The full paper on Intrinsinomics will be published in the near future.
Finance 3350: Personal Finance-Portfolio & Risk Management– Dr. Wendee started teaching Finance 3350 – Portfolio & Risk Management at California State University, Los Angeles (CSULA) starting January 2020. Dr. Wendee teaches courses in Management and Finance at CSULA. He will be teaching Finance 3350 – Portfolio & Risk Management at California State University, Los Angeles (CSULA) during the Summer term of 2020 as well.
Business 4970:Strategic Management – Dr. Wendee started teaching Business 4970:Strategic Management at California State University, Los Angeles (CSULA) starting January 2020. Dr. Wendee teaches courses in Management and Finance at CSULA.
Business 218 – Macroeconomics – Dr. Wendee started teaching Business 218 – Macroeconomics at California Baptist University (CBU) starting January 2020. Dr. Wendee teaches courses in Finance and Economics at CBU.
Dr. Wendee presented a paper on his new theory of economics known as, The Value Creation Theory of the Economy (also known as, Intrinsinomics), at the International Leadership Association’s annual global conference which was held in Ottawa, Canada last Fall.
Dr. Wendee is working on a financial planning modeling program which will be available in the near future. The modeling program is designed to assist anyone in creating a financial plan and is customizable for each person’s unique financial planning goals. A working draft of the model is currently in beta test with students. Click this link, schematic, to go to the clickable document under the subheading Financial Planning Process (Draft) in the Intrinsic Value Wealth Report to see a draft of the schematic for the new financial planning process.
Dr. Wendee has been developing an econometric model specifically designed to monitor and forecast the global economy as this current economic crisis unfolds. This new econometric model is based on other econometric models that he has designed and have used for many years. You can find some of these earlier models in Book # 6 – Simple and Effective Economic Forecasting in the sister website to this website which is called the Intrinsic Value Wealth Report. The new econometric model has been constructed with some additional tools and methods that he has learned and some that he has developed over the last several years. He will be talking more about this new econometric model in this Commentary over the next few months. His comments and forecasts on the economy and the markets going forward will be based to a significant extent on this new model.
Intrinsic Value Wealth Creation pyramid
We always conclude our commentary with a discussion of the Intrinsic Value Wealth Creation Pyramid. The Intrinsic Value Wealth Creation Pyramid is designed to show some of the major categories for building wealth. It is the result of many years of study of the wealth building process; experience working with clients who have built considerable wealth; and my own personal experience building wealth. Newsletter subscribers should consult the Intrinsic Value Wealth Creation Pyramid as one of many useful investment tools while considering their investment plans.
The chart in this section is an expanded version of the Intrinsic Value Wealth Creation Pyramid Chart referenced in the Forbes.com article entitled, Nine Of The Best Ways To Build Wealth.
RESOURCES
See our Resources section for links to economic and other resources used in the preparation of this Commentary.