1 Aug 2016
U.S. Equity Broke Through to New Record Highs But Skepticism Remains Elevated
After repeatedly failing to break through to new highs over the previous year, the Dow Jones Industrial Average and the S&P 500 finally broke through with gusto, moving to all-time highs.
S&P finally breaks through
This latest move continues the equity bull market that has been in place since 2009, with some investors increasingly worried about the possibility that it’s getting a bit long in the tooth. We counter that argument by noting that this appears to be one of the least respected bull markets of all time. According to ISI Evercore Research, to this point in the year, U.S. equity fund outflows have totaled around $85 billion—a record (even surpassing 2008 during the financial crisis); while inflows to bond funds have been close to $100 billion. One of our favorite quotes comes from Sir John Templeton when he noted, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” To us, it’s hard to argue that we’re anywhere near euphoria and in fact investors still seem quite skeptical. That’s not to say that there won’t be times of short-term investor enthusiasm which could lead to pullbacks, but a near-term end to the bull market doesn’t seem likely.
We remain neutral on U.S. equities, which means investors should remain at their normal long-term allocations and use volatility to rebalance around those targets. Risks remain, however, including any aforementioned spike in investor optimism, election-related uncertainty, as well as Fed-related uncertainty. Valuations are a bit rich, which suggests earnings will have to do more of the market’s heavy lifting.
Earnings season offers insight, while economy perks up
With global uncertainty still high, the view from the corporate suite becomes even more interesting. Commentary from second quarter earnings season has so far been relatively cautious, although the results have been better than the relatively low expectations so far. It appears the first quarter marked the trough in S&P 500 earnings, although the growth rate may not move back into the black until the second half of this year.
Meanwhile, the U.S. economy continues to show meaningful signs of improvement. The U.S. Citigroup Economic Surprise Index moved back into positive territory, and to its best level since January 2015; indicating economic releases have largely bested expectations. Initial unemployment claims continue to reinforce the much healthier employment data since the strong June jobs report. And wages are starting to perk up with average hourly earnings rising 2.6% year-over-year, and the Atlanta Fed’s Wage Tracker measure up a full percentage point more. This appears to be helping retail sales, which posted another gain in June, rising a solid 0.7% ex-autos and gas.
Additionally, housing continues to be a relative bright spot in the economy, indicating better confidence among consumers as well as buyers taking advantage of low interest rates. Housing starts rose a solid 4.4%, while building permits advanced by 1.5%.
Unfortunately not all is rosy, as business confidence remains low. There are some signs of light though, with the National Federation of Independent Businesses (NFIB) recently reporting that its optimism index rose to 94.5, besting expectations. But industrial production and capacity utilization readings—albeit up a bit over the past month—continue to indicate a lack of longer-term capital investments.
We continue to believe that the extremely low interest rate environment is contributing to this phenomenon, contrary to central bankers’ goals. We believe ZIRP (zero interest rate policy) and QE (quantitative easing) in their latter stages both dented confidence and incentivized companies to bias their spending toward stock buybacks over longer-term capital investments.
We’re in for an interesting few months!
Market expectations for a rate hike later this year have risen over the past couple of weeks, coming closer to what we have believed was the more realistic possibility. The financial markets have stabilized following the initial Brexit-related volatility, while economic data has improved; setting the stage for a resumption of rate hikes. And then there’s the drama-filled election. It is almost assured that this election season will be unlike any other. Once the conventions are over and we head into debate season—likely to break viewership records—expect more bouts of volatility.
New equity index records often generate investor excitement, but skepticism seems to be the consistent and dominant emotion this time. We understand this sentiment as risks and uncertainties persist; but we continue to recommend investors remain at their longer-term strategic equity allocations. It’s early still, but the fallout from the Brexit vote appears to be relatively limited at this point; however, we believe volatility will persist in the context on an ongoing (but maturing) bull market.
This material is issued by Charles Schwab, Hong Kong, Ltd. The information provided here is for general informational purposes only and has not been reviewed by the Securities and Futures Commission in Hong Kong.