This bull market has run for more than nine years and looks well-positioned to continue down a rougher road ahead. The positive fundamentals of economic and earnings growth remain intact, supporting modest but below-average equity returns, as we think we’ve moved into a later stage in the cycle, with rising interest rates and more volatility.
Double-digit large-cap earnings growth – Corporate tax cuts and global growth have lifted expectations for double-digit S&P 500 earnings growth this year, the strongest since 2010. First-quarter S&P 500 earnings rose almost 25% over the previous year. As a result, valuations have improved, with the S&P 500 trading at about 17 times forward earnings. As the chart shows, that’s slightly above its long-term average of 16.7, supporting our outlook for modest returns ahead following the past five years of above-average returns. As a result, make sure your portfolio isn’t overweight in large-cap U.S. stocks.
Smaller companies attractive – Small companies outperformed larger companies in the first half of 2018 and appear better-positioned to keep benefiting from lower U.S. corporate tax rates and the expected acceleration in economic growth over the next few quarters. In addition, many are less sensitive to the possible impacts of higher tariffs and the recent rise in the value of the U.S. dollar. Their valuations are in line with historical averages, making them an attractive opportunity to improve portfolio diversification.
Higher volatility likely – Bigger daily market moves, rising interest rates, the impacts of higher tariffs and concerns about midterm elections are likely to prompt pullbacks. Historically, stocks have dropped by 10% or more about once a year, with three or four declines of 5% or more. We expect better economic growth and double-digit earnings increases to provide support for rising stocks over time.
Higher volatility and rising interest rates don’t mean the end of the bull market. We continue to recommend investors own a wide variety of equity asset classes to help improve portfolio diversification. In addition, consider using pullbacks as opportunities to buy at lower prices.
Investing in stocks involves risks. The value fluctuates, and investors can lose principal. The prices of small-cap stocks are generally more volatile than those of large company stocks.
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