Independent Thinking^®

A Fine Balance: Managing Portfolios in Buoyant Markets

Is this market as good as it gets? Many important indicators are at or near their most bullish readings ever and would be difficult to improve upon.

The most notable and extravagant signs of economic health can be found in sentiment surveys – how people are feeling, not necessarily what they are doing. The economic outlooks and capital spending plans of corporate chief executives are at record highs, and measures of small business and consumer sentiment are at similar extremes. In short, animal spirits have been fully unleashed.

Expected corporate earnings and revenue growth rates, in the United States and abroad, have accelerated to levels rarely seen so long into an economic expansion. Earnings for the companies that make up the Standard & Poor’s 500 index are forecast to grow by almost 20% this year, propelled by corporate tax cuts on top of strong economic growth.

At the same time, inflation, a key variable in determining valuations, as described in our recent white paper, A Reality Check for Stock Valuations, remains low. (Indeed, it may be that corporate tax cuts ultimately prove deflationary, if companies compete by cutting prices.)
 
This is all fundamentally good news and could drive the market higher in the short term. Beyond that, there is a risk that a run of less sizzling growth could disappoint investors. A greater concern is that growth instead will accelerate to the point that the economy overheats, threatening higher inflation and compelling central banks to raise interest rates more aggressively. That almost certainly would increase the likelihood of a recession and cause the stock market to fall.
 
These are not the only risks that investors must factor into their thinking. The aggressive efforts by the Trump administration to rebalance trade could hamper the global flow of goods and services. This flow has served as an engine of prosperity during the last two or three decades, and indeed whenever it has been allowed to proceed unfettered. At their worst, the protectionist policies could incite a trade war. Many advocates of free trade accept that the United States would benefit over the long run from reducing its trade deficits with China and other large economies, but they warn that doing so probably would create pain over the short to intermediate term.
 
When gauging the potential impact of the simmering trade dispute, it is important to remember that the conflict with China is much larger than the dollars-and-cents trade balance figures would suggest. As Brian Pollak highlights in his article (click here to read), China is our main rival for global influence. Advanced technology will be as important to the competition between the two nations as are military and economic might. It appears that China has not just been buying American technology but acquiring it through coercion and sometimes theft. It has secured significant technology in automobile manufacturing, for example, by requiring U.S. and other Western companies building manufacturing facilities in the country to enter into joint ventures with Chinese companies. It is strategically important to limit these practices and to take other steps to protect advanced technology and intellectual property in general.
 
Other factors warrant a more cautious stance toward equities, including rising odds that the Democratic Party will command a majority in the House of Representatives after the midterm elections. That could amplify the discord emanating from Washington. It’s also important to note that Andres Manuel Lopez Obrador, the leading candidate in the Mexican presidential election to be held this summer, is from the extreme left. If he wins, it could destabilize a very important neighbor and trading partner. Current polls put him 20% ahead of his rival.
 
As usual, the economic and political backdrop is fraught with uncertainty, making forecasts for the stock market a challenging undertaking. There is no doubt that this has been a very long and rewarding bull market. At the same time, the yields on short- and longer-term fixed income assets are slowly becoming more attractive. We maintain relatively conservative and, we believe, realistic market assumptions, and will continue to diversify portfolios to protect and grow our clients’ capital.
 
John Apruzzese is the Chief Investment Officer at Evercore Wealth Management. He can be contacted at [email protected].
 
To view the Evercore Wealth Management white paper, A Reality Check for Stock Valuations, click here or contact us to request a hard copy.