Are we in the late stages of the business cycle and bull market?
This recovery began in June 2009 and the bull market began in March of that year. So we are more than 100 months into the period of equity appreciation and close to that in terms of economic expansion.
|August ’17||Y-T-D||1 Year||3 year||5 year||10 year|
|S&P/TSX Composite||+ 0.45%||– 0.50%||+ 4.21%||– 0.89%/yr.||+ 4.95%/yr.||+ 1.08%/yr.|
|S&P 500 (C$)||+ 0.36%||+ 2.81%||+ 8.65%||+ 12.46%/yr.||+ 17.42%/yr.||+ 7.13/yr.|
|MSCI EAFE (C$)||– 0.01%||+ 6.78%||+ 9.31%||+ 4.97%/yr.||+ 10.74%/yr.||+ 0.47%/yr.|
* Source: Equity Index and Currency Data: Bloomberg. Data as of August 31, 2017
Looking at historical price earnings ratios, the market certainty appears to be fully valued, even assuming earnings continue to come in better than expected. Remember though, historical multiples were established in a higher interest rate environment when 10-year U.S. Treasuries were yielding between 5% and 7%, versus just over 2% today. Remember, stocks compete with bonds as an investment. Current interest rates can support a higher multiple. While the market is always vulnerable to a 10% correction, bear markets are usually associated with a recession and there is no serious downturn in sight for the economy.
The Bank of Canada and the U.S. Federal Reserve have been moving from an accommodative monetary policy to a more restrictive one. There is the prospect of at least one more interest increase in Canada this year and possibly in the U.S. too. The European Central Bank is also talking about tapering its balance sheet expansion and, as a result, liquidity will not be as favorable for financial assets as it has been since 2008. These potential impediments to equity appreciation are being offset by: investors being optimistic but not euphoric, inventories are not excessive, unemployment is declining rather than rising, leading indicators are making new highs and inflation is modest. Accordingly, we could be several years away from the next recession or bear market.
More recently, the markets have been buffeted by North Korea’s nuclear threat. A military confrontation in the Far East is certainly high on the list of potential risks. While most agree that a severe response is called for, these moves would cripple North Korea and add to the suffering of its people. The popular view is that China would not implement such harsh sanctions on its neighbor with whom it does a lot of business. China wants to avoid the risk of a regime change that might lead to a combined North and South Korea. In the event of a war, it fears that immigrants would flood into China. It also wants a quasi-communist buffer between it and democratic South Korea. The Chinese appear to have two major objectives. The first is to become the largest economy in the world. (They are likely to reach that point sometime in the 2030s, even if their economic growth slows to only 4%.) The second goal is to play a major role in international geopolitics. If China took steps that forced North Korea to scale back or stop its nuclear weapons development program, this would catapult it to a highly respected position amongst leaders throughout the world. China also does not want a nuclear capability in the hands of an unpredictable dictator on its borders. It wants to avoid a conflict that interrupts its growth. These factors may induce China to become the key player in diminishing the North Korean threat.
The other major risk to the markets is the possibility of a serious policy error coming out of the White House. However, there seems to now be a new mood of discipline in the West Wing since John Kelly became chief of staff. While the President remains unpredictable, the organizational chaos that existed before Kelly took over has been transformed by his leadership. Steve Bannon’s departure is also a good sign that the White House is becoming more disciplined.
If the economy continues to grow at even 2%, interest rates will rise but they would remain at historically low levels because of modest inflation and all the liquidity that was created since 2008 and therefore not “compete” with the equity markets. At this point, there appears to be more opportunities in Europe, Canada and the emerging markets than in the United States. A favorable surprise this year has been the economic strength of Europe. Whereas a year ago the possible break-up of the European Union was actively discussed by investors, the Brexit vote has brought the countries closer together. Emmanuel Macron’s election in France has been a positive with increased cooperation between France and Germany.
In summary, I believe that conservative, actively managed and globally diversified portfolios will return at least mid-single digit returns over the next twelve months. Expected market pullbacks should be viewed as buying opportunities for long-term conservative investors.
Mailey Rogers Group is here to help and we welcome any questions you may have.
Senior Wealth Advisor
Director, Wealth Management
Mailey Rogers Group