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Are U.S. stock valuations at a tipping point?
4/20/2019 7:10:35 AM
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Investment management insights from a leading Canadian expert.

By Tyler Mordy  | Tuesday, October 23, 2018


Every now and then, the obviousness of a consensus view is so powerful that, few can imagine anything that might disturb it. That pretty much describes the current consensus view. While acknowledgement is given to the fact that U.S. equity valuations are at extremes, virtually all strategists believe a continuing bull market is still supported.

Only 10 years after the last bubble-unwinding, U.S. financial markets are again in a state of mass optimism; overpaying for risk and convinced of a halcyon future supporting even higher valuations. Though some might argue the evidence otherwise, a new asset bubble has again emerged. By definition, bubbles are usually the product of monetary largesse. So it is at present. However, the imbalances and extremes may be expressing themselves in different channels.

While relative valuation of U.S. equities versus the Rest-of-the-World (ROW) have been at an extreme overvaluation for some time, U.S. equities have continued to power ahead. But the negative factors are piling up.

For the time being, it remains consensus that the U.S. Fed will raise short-term rates a few more times. Higher interest rates are already biting U.S. growth. Interest-rate-sensitive sectors, such as housing and auto sales, are already turning down. Mortgage refi has slowed. The sugar-high stemming from a tax cut is not finding its way into consumption. It would not be a surprise if U.S. economic growth has peaked.

America is caught in a corrosive cycle. The more that it raises tariffs, the higher its trade deficit. This is the exact opposite policy outcome from what is wanted. Also, slumping currencies amongst trade competitors makes them more competitive.

As Anatole Kaletsky, the founder and co-chairman of GaveKal, observes: “In today’s interconnected trade world, nations that are a supplier of export goods stand to come off better than those who rely upon imports.”

As mentioned, the biggest consensus argument for a continuing U.S. equities market is that corporate earnings are continuing to expand in excess of 20%. Many strategists hang on this reed of support for their bullish stances.

Though the U.S. share of global GDP has declined from 32% (in 2001) to only 23% recently, its share values nevertheless now commands almost two thirds of the MSCI World market capitalization (62.14% at the end of August 2018). These two dynamics (which usually are expected to be correlated) cannot be expected to continue on their divergent paths for much longer.

Also, one must not overlook the role of U.S. corporate tax cuts this year, as well as the widening U.S. government budget deficit. These have been the primary drivers of corporate earnings growth in 2018. The tax cut will have a one-time impact. However, can the corporate sector expect rising deficits to boost income growth? Whatever the case, it would be safe to observe that a confluence of factors has boosted corporate earnings and that likely we will have seen the best growth rates for a time.

Given today’s equity valuation levels, it is virtually guaranteed that returns will turn lower…perhaps even negative for periods.

As Dr. John Hussman reminds investors “…extreme valuations go hand-in-hand with extreme losses over the completion of the market cycle.” At the very least, it is a defensible conclusion to expect very low, if not negative, equity returns over the next decade.

Tyler Mordy, CFA, is President and CIO for Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. He specializes in global investment strategy and ETF trends. This article first appeared in Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.

Notes and Disclaimers

© 2018 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

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