The third quarter continued the torrid pace of the global stock market rally that began last fall. So far this year, the S&P 500 has gained an impressive 14.2%. International stocks have also enjoyed a significant rise with the MSCI EAFE gaining 20.0% and the MSCI Emerging Markets Index rising 23.9%. The rally has been primarily driven by investor and business optimism, but the global economy also continues to grow, and in many regions, is picking up steam.
Over the past year, the market has remained remarkably steady, even in the face of political uncertainty, rising geopolitical risks, and tightening monetary policy by the Federal Reserve. September’s rise of 2.1% in the S&P 500 marks the eleventh consecutive month of positive returns, which is the first time this has happened in 58 years. Volatility, as measured by the VIX index has also remained well below its long-term average for nearly two years.
The ongoing stock market gains have caused many investors to wonder if the market has become overvalued and might potentially be heading for a big decline. Regarding valuation, it is hard to argue that stock prices have not become somewhat overvalued, but we do not believe they have become wildly expensive. The forward price-to-earnings (P/E) ratio for the S&P 500 is currently 17.7x versus the 25-year average of 16.0x. We agree that prices are above average, but they are nowhere near the stratospheric level of 25x reached during the peak of the late-90’s tech bubble. It is also worth noting that the investor euphoria that often accompanies market tops is conspicuously absent. We understand investor concern about the new highs the stock market has reached, but new highs do not necessarily equate to new peaks.
International stocks have been among the best performers this year. After years of economic struggles, it appears that many regions throughout the world have regained their footing and are beginning to gain momentum. In the developed world, stock markets in Germany and France have enjoyed especially strong returns this year with gains of 25% and 28% respectively. In the emerging markets, Chinese stocks have led, returning 43.4% this year.
Over the past year, the Federal Reserve has implemented three interest rate hikes and has begun planning for actions to reduce the size of their balance sheet. The Fed is expected to raise rates one more time this year, and possibly two to three more times next year. In contrast to recent years, when the market was quite sensitive to Fed activity, the market has largely ignored the Fed’s latest actions, demonstrating growing confidence among investors in the strength of the economy.
After falling to a low of $30 per barrel in early 2016, crude oil has steadily risen to a much more comfortable level of $50 per barrel. Although still well below the $100 +/- level enjoyed by energy companies from 2011-14, the 60% rally in oil prices from last year’s low offers some welcome relief for the energy complex, and has greatly improved profitability for the sector.
President Trump recently announced plans to revise and simplify tax laws for businesses and individual taxpayers. The proposed changes would lower tax rates and eliminate some unpopular taxes for individuals, such as the Alternative Minimum Tax and the Estate Tax. If passed, the proposed changes would boost corporate profits by reducing the corporate tax rate from 35% to 20% and would lower taxes for many individual taxpayers, further stimulating the economy. Critics of Trump’s tax plan are concerned that lower tax revenues could cause the budget deficit to widen and the national debt to grow more rapidly.
The U.S. economy continues to show signs of strength and has entered its 99th month of expansion. This ranks as the third longest expansion in U.S. history. Although the pace of the expansion has been below average, the steady and measured growth has likely contributed to the long duration. Recent economic readings have continued to confirm the positive trend. Real GDP growth was measured at 3.1% in the second quarter, and unemployment has fallen to 4.2%. In many important areas of the economy, there are clear and positive signals of ongoing strength.
The concern we are currently hearing most often from our clients is their worry that the long bull market and recent market highs will come to an abrupt end and a bear market decline will follow. J.P. Morgan identifies four major risk factors that are most often responsible for bear markets; economic recessions, commodity price spikes, aggressive monetary policy tightening, and extreme stock market valuations. Evidence suggests that the economy is strong, commodity prices remain far below recent highs, the Fed has taken a measured approach to tightening their monetary policy, and the stock market is only slightly above fair value. So it doesn’t appear to us that any of the four risk factors are currently present. As such, we remain cautiously optimistic that bull market can continue for the foreseeable future.
Thank you very much for your continued confidence in our service and advice. If you would like to discuss our opinions, outlook, or your portfolio in greater detail, we would be happy to schedule a meeting or a conference call at your convenience. Lastly, don’t keep us a secret. If you know someone who would like help planning for their financial future, we will be pleased to speak with them to see if we can assist.
Horizon Advisors is a Houston based fee-only wealth management firm. Horizon specializes in helping successful individuals and families understand, organize, and manage their often complex financial situations. Horizon offers integrated financial planning and investment management services.