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The Markets This Week

July 16, 2019 | Weekly Commentary

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Most major U.S. equity indices closed out last week at all-time highs, bolstered by seemingly solidified expectations that the Federal Reserve will opt to cut interest rates when it meets in just a couple short weeks. During his semi-annual testimony on Capitol Hill, Fed Chair Jerome Powell noted that uncertainties surrounding global growth and trade continue to cast a shadow over the economic outlook and that inflationary pressures may remain persistently weak. Despite these risks, the general tone of Powell’s comments was still relatively sanguine, supporting our own view that the economy remains relatively healthy, but that increasing weakness abroad could put a cap on the strength of future growth rates.

Setting Expectations
As long-term investors, one of the most important keys to success is discipline. However, maintaining that discipline over the course of a complete market cycle can be very challenging. Volatility can be difficult to bear, especially when the future seems uncertain and our financial well-beings are at stake. That is why we believe one of the best tools an investor can have is a realistic impression of what can be expected from their portfolio. That way, when that next “crisis” inevitably strikes, the element of surprise is diminished, and a decision based on emotion is less likely to be made.

The S&P 500 closed above 3,000 for the first time in history last week. A variety of factors have allowed stocks to climb to all-time highs this year, including expectations for easy monetary policy from the Fed, perceived progress with U.S.-China trade negotiations, and relatively healthy U.S. economic data. But with the U.S. stock market now up close to 20% over the past six months, it is important for investors to set expectations for the future of long-term returns.

For most of us, remaining disciplined requires an understanding of economic fundamentals and valuations, which are the two most important drivers of long-term returns (not Fed policy or trade relations). It is a core tenet of investing that valuations are an efficient predictor of future returns, and that buying stocks when they are cheap has historically been much more successful than buying stocks when they are expensive. Of course, after a strong 20% run over the course of just six months, stocks are more expensive than they were just a short time ago, but the good news for investors is that by most measures of valuation, stocks are still far from “bubble” territory. The current P/E ratio for the overall market stands at about 17x (meaning that investors are paying $17 today for every $1 of future profits), which is much lower than the 25x level that was seen during the tech bubble in the early 2000s. However, compared to the historical average of about 15x, stocks certainly are not cheap either.

As the current economic cycle continues to mature, it will be important for investors to recognize that from current levels, future returns are likely to be a bit lower than they were during the past several years. Luckily, even returns that are meaningfully lower than those achieved during the bulk of this bull market can still be robust enough in a world where inflationary pressures remain muted. With that in mind, if we are able to successfully reset our expectations, we are likely to put ourselves in a much better position to navigate future volatility with better grace and discipline. Often times, staying invested and avoiding the opportunity costs of missed profits can give us a head start on a prosperous retirement.