The last stages of a bull market prompts investment pundits and professionals to make more than their usual predictions about the imminent market declines that are on the horizon. In contrast to the early stages when few are willing to forecast a bull market is in the cards. Future bull markets are born out of recessionary declines; future bear markets come from either frothy valuations or deteriorating economic fundamentals, or events that might cause the economy to contract. The current bull appears to have outrun economic fundamentals. Still, trying to time a downturn risks missing out on more gains.
Asset Class Review
Low interest rates kept money invested in equities. Year-to-date, international stock markets across all three benchmarks we track delivered better returns than the S&P 500. International markets remain more attractive than the US based on valuation. And though the US has vastly outperformed international markets for the past 3, 5, and 10 years, using history as our less than perfect guide, this pattern is due to shift.
REIT and bond returns performed better than the prior quarter as interest rates moderated. Commodity returns continue to struggle, mostly due to oil overcapacity. Oil prices are typically cyclical. OPEC producers like to make agreements on limiting oil production to help bolster prices. In theory, limiting supply should work. However, theory doesn’t account for members who don’t honor agreements, so they might gain market share. Add US shale oil production, increasing auto electrification, and rising use of renewable energy sources – oil pricing may become ever more competitive.
Calm Amidst the Storms
Traders remain calm despite uncertainties around government policy and fundamental economic issues (i.e. failed attempts to repeal the Affordable Care Act, threat of trade wars, and the promise to write a new tax code). Then there is nuclear sabre rattling sound coming from North Korea. Hurricanes have disrupted economic activity in Houston and large swaths of Florida, Puerto Rico lies in ruins, and California’s wildfire devastation. Yet the bull market keeps moving higher.
Why? The underlying fundamentals of the economy are very solid at this stage in a long, slow economic expansion. Corporations reported a better-than-expected second quarter earnings season, with adjusted pretax profits reaching an annualized $2.12 trillion. Consensus forecasts are optimistic. Unemployment continues to trend downward and wages trend slowly upward. The economy grew at a 3.1% annualized rate in the second quarter, about a percentage point higher than the recent averages and marks the fastest quarterly growth in two years. And there is hope the new tax package will prove as business-friendly as promised. Time will tell.
Economists tell us that the hurricane damage that slows economic growth in the third quarter, will be offset by the building boom that will be fueled by the destruction. There are no current economic indicators that would signal a recession on the near horizon. The Federal Reserve Board appears it will remain cautious in raising interest rates.
Meanwhile, as the chart below illustrates, fourth quarters have historically been kind to investors—much kinder than third quarters.
There are still potential speed-bumps. The Trump Administration has threatened multiple trade wars with America’s major trading partners. Tight immigration rules could lead to limited labor supplies, higher wages, and lower profits. Pessimism yawns when portfolios grow incrementally every quarter.
Stay Your Course
If the U.S. charts a prudent economic course, it’s possible that the current expansion could set new records for longevity. This current expansion is 99 months old; the record high is 120 months (1991-2001). When it ends, nobody can answer. Ignore the forecasters noise, stick to your allocation (which should match your time horizon and your tolerance for volatility), and rebalance when the inevitable correction occurs. Time in the market is how you make money; timing the market is how you leave money on the table.
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