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
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 firstname.lastname@example.org. Follow
Tyler on Twitter at @TylerMordy
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