Stocks have rebounded near all-time highs, but conditions have shifted since the last time they were at this level. Economic growth is slightly softer, Federal Reserve policy is easier, and interest rates are lower. However, market fundamentals remain reasonably sound. Strong first-quarter gains have raised the bar for extended Fed stimulus, a U.S.-China trade deal and stabilizing growth, which also raises the potential for short-term disappointments.
Earnings under pressure but still helping –Corporate earnings growth, which has accounted for nearly half of the total return of the stock market over the past decade, should remain a pillar of support for the bull market but is likely to slow this year. Overall earnings for 2019 are forecast to grow by low to mid-single digits, helped by positive GDP and healthy revenue growth. Looking back to 1955, when stock prices declined in a year when earnings increased (similar to 2018), the average return in the following year was 7%.*
Volatility is down, not out – Market volatility rose notably in 2018, but markets have rebounded near previous highs. Expectations for no rate hikes this year and a trade agreement between the U.S. and China have largely been priced into stocks at this point. All of these raise the potential for disappointments and are likely catalysts for market volatility this year.
Late-cycle conditions – We think there is still mileage left in this positive cycle, as multiple warning lights of a bull market’s exhaustion are not yet flashing. But with a total return of more than 400% for the S&P 500 since the bull market began, it’s likely past its prime. We think that as this bull market advances, modest economic and earnings growth, balanced with credible risks from monetary policy changes and the global economy, will produce more average-looking gains than the 18% average annual return over the past 10 years.
We believe an allocation in the middle of the equity/fixed-income range is appropriate. Later in the market cycle, volatility increases and leadership often rotates, which we think supports the case for rebalancing and asset class diversification. U.S. stocks have been the strongest performer during this bull market, but we believe international equities offer an attractive opportunity for diversification.
*Past performance of the markets is not a guarantee of what will happen in the future.
Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.
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