Is It Time to Take Less Risk?
August 15, 2017
With stock markets globally setting new highs, many clients are asking if it’s time to reduce their equity allocation. Our answer: While there’s plenty to worry about, there’s good news, too. Thus, long-term investors should maintain their strategic allocations.
Among the principal concerns for worry are US stock market valuations well above their historical averages. Some investors also fear that length of the recovery alone indicates that a correction is due. Extremely low volatility, despite unnerving geopolitical and social tensions, is also unsettling.
But there’s a reason for the extended rally and market calm—and it has nothing to do with expectations for fiscal stimulus in the US, as evidenced by the outperformance of non-US stocks this year. Earnings growth has accelerated globally, as the Display below shows. While earnings growth and market returns are not necessarily correlated over short time periods, today’s modest, but synchronous, mid-cycle acceleration in global economic growth is providing support to both.
It’s possible that the strong stock market gains over the past year may reflect much of the positive news on earnings, and that earnings could disappoint loftier expectations. But there are strong fundamental reasons for this earnings growth, as we have explained in a prior post.
Yes, policy missteps could disrupt the economy and markets. Historically, low interest rates have supported the prices of stocks and other assets for years; now the US Federal Reserve is raising rates and preparing to let its swollen balance sheet shrink, and other central banks are also expected to become less accommodative. While central bank rate hikes are widely expected to be gradual, well telegraphed, and appropriate to economic trends, more rapid or larger-than-expected monetary tightening could disrupt markets.
Nonetheless, we expect near-term earnings growth to help equity markets withstand potential headwinds. We project global stock returns of nearly 7% over the next five years, lower than they have been historically, but better than expected returns from other liquid financial asset classes, such as bonds. And bonds may be riskier than usual over the next few years.
Within equities, non-US equities look more attractively valued than US stocks. For investors who utilize tactical overlays, we think a small tactical overweight to stocks, focused in developed Europe and emerging markets, makes sense in the current environment. For more on this topic, see “Follow the Earnings.”
The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.