While media remains fixated on the White House, the markets during Q2 were more attuned to corporate results and central bank activity. Investors saw solid gains and a smooth ride with the S&P returning 3.1% for the quarter – it was never up or down more than 2% in any of the three months. International stocks outperformed the United States for a second straight quarter.
Markets Focus on Corporate Growth, Not Politics
While much of the world’s attention has been focused on Trump and the administration’s next steps, the market has been more focused on economic and corporate growth than speculation around politics. Earnings growth for the S&P 500 during the third quarter is estimated at a healthy 6.6%, supporting high valuations and rising prices. With yields near all-time lows on much of the curve, the upside from owning bonds has decreased, but we believe they offer valuable diversification from stocks and should be a part of most portfolios.
U.S. Stocks, Central Banks & Timing the Market
U.S stocks are relatively expensive right now with the S&P’s PE ratio sitting at 25 (as of July 10, 2017) For stocks to produce further gains, either earnings must increase or valuations must get more extreme. One challenge to this is that profit margins are already at or above multi-decade highs for a multitude of reasons, ranging from stagnant wages to low interest rates on debt to tech-driven lowered costs.
Central banks have been instrumental in fueling this bull market. The Fed raised short rates by 0.25% in June, also announcing plans to shrink its balance sheet by letting bonds mature without replacing them, which created a mild headwind for stock and bond prices. The European Central Bank began to hint at its intention to start reducing monthly stimulus purchases, which drove the Euro and global bonds higher.
Some investors are frightened by all-time highs in stock prices and remain on the sidelines or maintain very high cash allocations. In our view, this is the classic mistake of trying to time the market, and one may end badly for those who try.
The Stock Market & Shrinkage
There is a shrinking count of publicly listed U.S. stocks right now, but it doesn’t mean the market is worth less. At close to $30 trillion, the value of the U.S. stock market is at an all-time high. There are fewer listed companies, but the bigger ones are much bigger. More available private equity and venture capital dollars are allowing companies to stay private longer, and greater regulatory requirements are discouraging some companies from going public. Additionally, consolidation and acquisition is fueled by low interest rates and cheap corporate debt. If the shrinking number of listed companies accelerates, it may change the nature of the public stock market in the long-term, but we don’t see it as a major concern for now.
FANG & FOMO
Large tech-driven consumer companies are the current darlings of the investing world, which means the term “FANG” is coming back in vogue. Jim Cramer coined this as an acronym for Facebook, Amazon, Netflix and Google (though some have expanded it to include Apple and Microsoft). These six stocks were up an average of ~22% in the first half of 2017, which has led some to experience “fear of missing out” – or FOMO. A counterintuitive yet self-perpetuating cycle has begun where rising prices create higher demand. This is nothing new when it comes to investments. We’ve seen it many times and it usually ends badly. Our advice is to take full advantage of the amazing products and services that come from Apple, Facebook, Amazon, Microsoft, Netflix, and Google. And don’t let that other acronym, FOMO, drive your strategy. It is can be the enemy of long-term success.
With valuations high, we believe it’s still more important than ever to have a strategic asset allocation, with diversification being critical to managing risk and maintaining upside potential. And as popular consumer-oriented tech stocks have become a bigger part of the market, some investors are experiencing FOMO. We urge caution around excessive exposure to these companies; remember that the most popular investments can also be the most dangerous.
To learn more about this quarter, read our free Q2 Market Review and Commentary.