As a resident of Florida, Google informs us that our community’s distance above sea level measures a whopping 6 feet.  Perhaps it’s small wonder we need to be extra thoughtful when visiting high-altitude destinations.  In extreme cases moving to great heights quickly may cause severe discomfort which can only be remedied by quickly descending to lower altitudes.

The earth’s atmosphere extends roughly 300 miles up and the weight from the air above us places downward pressure on our bodies which at sea level measures about 14.7 pounds per square inch (psi).  Most of the molecules in our atmosphere are compressed around us close to the earth.  As we move higher in altitude those molecules become increasingly sparse.  The percentage of oxygen throughout the atmosphere remains a fairly constant 21% regardless of altitude.  However, there is simply less atmosphere and therefore less oxygen molecules as we ascend.  At 12,000 feet we breathe roughly 40% less oxygen than at sea level.  At 18,000 feet we breathe 50% less oxygen.

Denver, Colorado sits at 5,280 feet above sea level which is exactly one mile, hence Mile-High City.  The psi in Denver is only about 12.  Commercial airplanes pressurize their cabins to about 12 psi to keep passengers comfortable, so breathing in Denver and breathing on an airplane feels about the same.  Once we go higher things begin to become less comfortable.

There are few places in the States of any significant population that are high enough for people to reasonably expect altitude sickness upon visiting.  Among the highest populated in the US that qualify as high altitude, defined as 5,000 to 11,500 feet above seas level, are Santa Fe, New Mexico, (6,818 feet), Flagstaff, Arizona (6,834 feet), Mancos, Colorado (7,017 feet), Park City Utah, (7,034 feet), Mammoth Lakes, California (7,880 feet) and Vail, Colorado (8,120 feet).  Athletes like to train at higher elevations because the thinner air causes the body to produce more red blood cells to deliver sufficient oxygen to muscles.

Amazingly there are many cities in the world who are at the higher end of “high-altitude” and into “very high-altitude” (defined as 11,501 to 18,000 feet above sea level) such as the capitals of Ecuador (Quito, 9,350 feet) and Bolivia (La Paz, 11,942 feet).  Tibet, the province of Qinghai, China, India and Peru all have settlements over 15,000 feet above sea level.

What we refer to as altitude sickness is actually more formally known as Acute Mountain Sickness or AMS.  Typically, it occurs when people visit altitudes of over 8,000 feet above sea level.  It has little or no relation to how “fit” a person is, as an “out of shape” person may experience no effects while an Olympic athlete may become extremely ill.  Symptoms include but are not limited to shortness of breath, loss of appetite, loss of coordination, dizziness, inability to sleep well, nausea, and muscle aches.  Generally speaking, with altitude sickness one must either acclimate or seek lower ground.

Here it comes, we know you’ve been expecting this all along.  There are some striking similarities between the effects of altitude sickness and what happens when the market continues to reach new highs.

• The higher you go, the harder it is to go higher
• The faster you ascend typically the worse off you are
• Acclimation becomes increasingly difficult the higher you go; often a retreat to lower ground is necessary
• The effects of extreme altitude are varied, and unpredictable

Assuming you accept my anthropomorphizing (assigning human characteristics to non-human entities) premise then the question becomes, is the market truly at sufficient altitude to concern ourselves?  More so, that a retreat to lower altitude is likely if not imminent?

We believe the answer is not as simple as looking at the absolute value of market indices, such as the Nasdaq which at the time of this writing is at its highest value ever.  The popular Dow Jones Industrial Average is a stone’s throw from its “all time high”.  However, the underlying nature of the markets is that all things being equal stocks and therefore stock market indices should grow over time.  We believe this to be true because companies should be able to increase the price of their goods and services to account for inflation.  Again, all things being equal this should translate into higher earnings per share which in turn translates into a higher stock price.  If it’s true that the natural tendency for markets is to go up, then at some point we should expect to see “all time highs” regardless of what else is happening.

We do not mean to imply that our recent market highs are merely a result of the natural way of things regardless of outside influences.  Far from it, we believe that the past two years have been heavily influenced by events beyond corporate profits and inflation expectations.  Chief among those things are the 2018 Tax Cuts and Jobs Act, and fears of trade wars as the administration attempts to renegotiate trade between the US and… pretty much everyone else.  Many look to the possibility of the impeachment of a sitting president as a major risk for the markets.  While we believe that an impeachment would short term create market turmoil, a look back to President Bill Clinton’s impeachment showed a remarkable 30% gain between his scandal breaking in January, 1998 to the defeat of his articles of impeachment in the senate, February 1999.

A better way to judge whether stocks are overly high is to think of them relative to other things, rather than just looking to the number of an index.  One such relative measurement is to look to the price of stocks relative to their earnings.  This simple calculation divides the price of stocks or indices, by that particular stock or index’s earnings per share.  As of this writing the price of the stocks in the S&P 500 (our index of choice) divided by the earnings of the same gives a PE Ratio (or PE) of 24.  While we have certainly seen higher market PE ratios at various times in the past we would classify a PE of 24 as being at the very upper end of “normal”, perhaps into “expensive”.  Said another way relative to companies’ earning stocks are not cheap and may be thought of as “moderately higher than their natural tendency”.

Here is a chart of the PE Ratio of the S&P 500 going back 90 years, you will note that typically the PE Ratio of the S&P 500 is at or below 20.

S&P 500 PE Ratio – 90 Year Historical Chart

Returning to our premise that stocks, like humans, may experience difficulties when ascending quickly and when they reach heights far from their natural environment we have to ask ourselves, what events or circumstances are on the horizon that would lead us to conclude that rather than pull back the market can either acclimate to this altitude or continue to move higher?   Unfortunately there aren’t many likely super bullish events on the near term horizon.  While the administration may get a second swipe at tax cuts or negotiate some better trade deals while positive for stocks we don’t see these as motivations for the market to take another big leg up.  What would have to improve, in our opinion is corporate profits and it’s difficult to see how much more they can improve year over year.  They’re already very healthy and the explosive growth we have seen probably isn’t sustainable longer term.

We are not predicting a swift or sizable market pullback though we cannot rule it out.  In our experience even the most respected of financial analysts have a pretty poor track record when attempting to predict anything other than their ability to predict well.  The better course of action we believe is to tactically adjust portfolios given information the market provides us.  We do not feel wholesale strategic reshuffling of accounts to sell out of stocks is warranted, rather continued trimming of existing positions and in some cases reducing equity exposure to the lower end of our clients’ investment objectives.  While there does not appear to be any significant bullish events on the horizon there also do not appear any major bearish events.  Whether the president is impeached or not the likelihood the Tax Cuts and Jobs Act is scrapped is unlikely any time soon.  The likelihood corporate profits fall dramatically is also remote.  The most likely scenario is that the market takes some time to acclimate, and for earnings to catch up to stock prices.  If that’s true, then why assume the risk of overweight stock allocations?  If one expects muted returns, wouldn’t one prefer to earn those returns in assets that are less volatile?

So what are next steps for you?  Our clients entrust us to make informed, prudent adjustments in their portfolios on an ongoing basis so we’re already positioning ourselves on your behalf, you need not do a thing.  As always, if you would like to discuss the specifics of how we are adjusting your portfolios please feel welcome to contact me directly, we love talking shop!