A bull market can be like a long road trip – an exciting journey, but one with unexpected set backs, sometimes bumpy roads and the occasional pit stop. The global markets are each at a different point on this road trip, with the U.S. having come the farthest because we were the first to get started. Last year congress gave U.S. stocks an important boost with a corporate tax cut. Think of the tax cuts as the cup of coffee that keeps us driving an extra distance, but that cup is due to run out. The lower corporate income tax rates will stay, but their ability to move the needle on profit growth is a one-year affair. Meanwhile, the rest of the world that started after the U.S. did hasn’t made it the same distance, but as a result, has more gas in their tanks.
One of the biggest investments stories of 2018 has been a higher return on U.S. stocks as measured by the S&P 500 versus the other major investible asset classes. Over the past few weeks, U.S. stocks have joined the others in a downturn, too, though they still remain in the lead for the year.
U.S. stocks as measured by the S&P 500 are still slightly up for the year 2018. Using the S&P is a measure of one part of our portfolio and illustrates that this part of the portfolio has done the best. The reason for the disconnect is that the other three major markets that we include in building a diversified global portfolio are flat to slightly down so far this year. The chart below plots how the various markets have behaved in 2018.
U.S. Stocks – Have responded to rapid earnings growth driven by tax cuts. This has helped them to deliver returns higher than the rest of the world in 2018, but there are limits to how long this can run. The big driver this year, earnings growth from tax cuts, is a one time item that cannot have a replay next year.
Bonds – As measured by the Barclays aggregate bond index are flat to slightly down. Rising interest rates have put a hurdle to earning better returns in bonds this year, but they actually increase yields and potential returns going forward.
International Stocks – As measured by the MSCI EAFE, international stocks enjoyed strong returns through late January, but have diverged from U.S. stocks starting in mid-May. One of the bigger drivers here has been diverging currency values. The underlying earnings are growing at an even more rapid rate than earnings in the U.S., and that’s without the benefit of tax cuts. The developed world is doing a lot of catch-up with the U.S., which creates the potential that they can continue to grow because 2018’s figures aren’t tied to tax cuts. Also important – they’re trading at big discounts relative to U.S. stocks.
Emerging Markets – As measured by the MSCI EM index are the biggest disconnect to date. Here again, the fundamentals are solid. Emerging Market stocks are growing profits at rates faster than American peers, and are significantly cheaper in terms of valuations. Their stock prices have been hit this year by trade-war worries. And for this portion of our portfolios, we are confident in the potential for a recovery because of a combination of bargain valuations and rapid earnings growth in EM stocks. This is the asset class that tends to hit the highest highs and the lowest lows, and we’ve experienced both in just the last two years. Last year the Emerging Markets were the best performer in this group, delivering a 37% gain while the other asset classes were up more modestly.
This trend of just U.S. stocks leading the pack can’t continue forever, and there’s a good chance that it can reverse in the near term. One factor keeping U.S. stocks aloft – last year’s corporate tax cuts – is a one-time shot in the arm that will stop boosting profit growth by the end of the year, and that’s going to make U.S. stocks lose an important edge. The rest of the world is growing their profits as fast or faster than American companies and without the benefit of this one-time item, and investors will notice this divergence in growth and bargain valuations. The biggest thing stopping that today is the trade war headlines. U.S. stocks have acted as a trade-war safe haven, and investors may rotate back into assets abroad as either the headlines ease or especially if the fundamentals stay strong regardless of the headlines.
The chart below plots the S&P 500, or “the market” as we hear about in the news, as well as the other markets that make up our global portfolios. This year U.S. stocks made it further down the road thanks to our tax cut coffee, but as I look to the future it’s the other markets that have more gas in their tank and the opportunity to travel farther in the future.
Additional Important Disclosure Information
S&P 500 Index. The S&P 500 is an index consisting of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Each constituent in an index is weighted by its market-capitalization, as determined by multiplying its price by the number of shares outstanding after float adjustment.
Barclays Capital U.S. Aggregate Bond Index. A broad-based benchmark that measures the investment grade, U.S. dollar-donminated, fixed-rate taxable bond market, including Treasuries, government-rated and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS. The index was created in 1986, with index history backfilled to January 1, 1976.
MSCI EAFE. The MSCI Europe, Australia and Far East (EAFE) Index is a free float-adjusted market capitalization weighted that is designed to measure equity market performance in foreign developed markets. The index represents about 85% of the market capitalization of developed markets outside of North America.
MSCI Emerging Markets Index. The MSCI Emerging Markets Index is a free float-adjusted market capitalization weighted index that is designed to measure equity market performance in the global emerging markets. The MSCI Emerging Markets Index consists of the following 23 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey, and UAE
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