Brick By Brick
Revisiting the “wall of worry”
Let’s go back to the beginning of summer. At the time, we wrote an article, The Wall of Worry, covering the three “bricks” that are forming a “wall of worry” for U.S. markets:
1. U.S. – China trade tensions
2. Rising interest rates
3. Fears over an aging cycle
Back then, we concluded that these issues, though worth monitoring, wouldn’t derail global growth or our belief in continuing to overweight stocks versus bonds. Within stocks, we emphasized the importance of including non-U.S. markets in a diversified portfolio, given positive growth dynamics abroad.
As we now enter autumn, the same three bricks are still the main components of the wall of worry. However, our assessment of them has evolved with the changing landscape, especially as trade tensions have escalated materially. While we still think stocks look more attractive than bonds, and global diversification remains important, we believe that U.S. stocks stand to outperform international stocks over the next year.
A Second Look at the Three Bricks
“We expect the U.S. to continue to outperform through 2018, particularly given forecasts for roughly 24% earnings growth this year.”
“We think it could be as long as a year before short-term interest rates exceed long-term rates, and stocks don’t typically peak until well after that happens.”
S&P 500 returns, from yield curve inversion to market peak
In the last five instances, U.S. stocks gained an average of 18% after the yield curve inverted - and that hasn't happened yet in the current cycle.
“Although we may be in the later stages of the cycle, we aren’t at the end.”
What does it all mean for you?
There’s no denying that these bricks continue to contribute to a wall of worry for investors. Yet stock markets seem to be identifying the risks and reacting accordingly—in other words, they’re slowly climbing the wall. Across nearly all geographies, stock valuations have declined since May, signaling that the markets share our same worries (see chart). Just as importantly, like a car that has slowed from 60 to 40 mph, those cheaper stock prices help reduce downside risk should things go wrong.
Current stock market valuations
Price to earnings ratios
Across the world, stock valuations have declined from market peaks and now look more attractive.
“Stock returns can be strong in the final phases, and bond yields become more compelling as interest rates rise.”
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