With summer now officially upon us it seems like the excitement that many of us have witnessed in schoolchildren who are newly on summer break has carried over into the markets. The S&P 500 rose an additional 2.6% in the last three months bringing this year’s total growth to roughly 8.2%. The long-term bull market we have been in (the second longest on record) has many investors concerned about how much longer the bull market can continue. At its most fundamental level the equity markets are driven by the economy and corporate earnings. Which brings us to the key question: will the current economic environment support continued growth into the future?
Our research indicates that it does…for now. No one holds a crystal ball that allows them to perfectly predict the future. However, based on our broad analysis of corporate earnings reports and key economic indicators ranging from inflation, economic leading indicators and productivity we do not see a near-term recession on the horizon. As a result, while we recognize that we are now in a late stage of the market cycle, we do not expect to see a large-scale correction in the near-term.
With this in mind, however, there are some key characteristics of the current market environment that we believe are worth noting as intelligent investors:
- US Stock Market Valuation: If we look at the US stock market from where we have been using the trailing 12 months price-to-earnings ratio for the S&P500, it is currently at roughly 23.8x versus the historical mean of 15.7x. Looking forward using the projected earnings of the S&P500 we get a price to earnings ratio of 18.7x, much closer to the historical mean. This implies that corporate earnings will grow at a faster rate than stock prices over the next 12 months. In a market like this it is important to find value investments with low PE ratios that are growing earnings and/or growth investments that have accelerating earnings.
- European Opportunity: The international markets, which have largely trailed the US post-recession recovery, are beginning to show signs of life. Europe, in particular, looks promising to us. For example, in the first quarter of this year the earnings of Europe’s largest companies grew by 9% more than those of comparable US companies.1 Additionally, the European Union, under the implicit leadership of German Chancellor Angela Merkel, seems to have found newfound commitment to one-another, which is important since Germany will need to continue financially supporting its southern neighbors to keep the EU together.
Some investors have remnant concerns about the effect that Britain’s exit from the Union (“Brexit”) will have on the region. While we acknowledge the difficulty of the situation, we believe that both sides will engage in significant political posturing to appear strong to their respective constituents but will ultimately make a deal behind the scenes that is acceptable, although not enjoyable for either side. Britain is the EU’s second largest trading partner after the US and consequently neither side will prosper if too many barriers to trade are created. We would also note with some humorous solace that July 4th represented our own “1776 Brexit.”
- Financials: Financial stocks, particularly bank stocks, have underperformed relative to many of the other sectors for most of the past quarter. We believe there will be a reversion to the mean in terms of performance as many of these investments look inexpensive compared to other sectors. While the lack of robust inflation and the delay in congressional actions have softened investors’ appetite for banks we do not believe that will last in the long-term. Despite legislative delay we still believe that before the 2018 mid-term election we will see some tax reform along with continued deregulation of the banks which will help boost earnings and thus share prices. The largest US banks also have significant international operations and will benefit from global growth, especially in Europe.
- Floating Rate Investments: As long as the US economy continues to grow the Federal Reserve will likely continue to increase interest rates slowly over time. Since many investors diversify a portion of their holdings into bonds they may find it useful to put a percentage of that allocation into bonds or bond vehicles that adjust upwards with inflation (“floating rate”).
While the above bullets focus on four investment themes that we believe are relevant at this time, they do not cover all of the many variables that our investment committee looks at each quarter. As a result, if you have any questions please do not hesitate to reach out.
I hope you have a wonderful and fun-filled summer,
Susan McGlory Michel
Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.