Invisor Economic Update July

Economic Update July 2017: Trust the Fundamentals

by Josh Miszk Last updated on August 02, 2017 Tags: Market & News Updates

With seemingly endless surprises coming out of Washington this past month, the lack of confidence in US politics has put pressure on the US dollar. In Canadian dollar terms, that pressure has manifested in weak returns across global developed markets.  

Index performance graph*Equity Indices - FTSE Global Indices in CAD, Bonds - Barclays Global Aggregate Canadian Float Adjusted Bond Index

With the political turmoil in the US adding to uncertainty by the day and US stock markets nearing all-time highs, many investors are wondering whether stocks have hit their peak. While we’re not a proponent of timing the market as there are many proven reasons why it is not a successful strategy and there’s no way to truly know what’s around the corner, we do feel that there are several reasons to stay the course.

Don't listen to your cab driver

The lesson behind the old adage of avoiding a “hot stock tip” from your cab driver is that whatever apparently new information you’ve learned has already been accounted for and priced into the market. The stock market is essentially a cardiograph of the global pulse. Any new news is priced in immediately, and investor sentiment shapes the reaction to that news.

One of the reasons we remain in the weakest recovery of the post-WWII era is that investors are still holding an unprecedent amount of cash on the sidelines waiting for that uncertainty to subside.  This lack of investment has kept the annual growth rate around the 2% level in the US since the recovery began in 2009. 

The global pulse today is one that’s frightened by what could be spun out of the White House next, or how the economy would handle a presidential impeachment. This near-term political worry builds itself on a foundation of the already weak investor sentiment that has kept investments in cash. You can rest assured that the expectations of any fallout are already priced into the market. 

Building a solid foundation

The more captivating story is that despite this sentiment, US markets are still at or near all-time highs.  Why? The real driver behind the growth is good old-fashioned fundamentals.

Earnings momentum is on the rise in the US, Europe, and emerging markets. Corporate earnings growth on the S&P 500 companies in the 1-year to March 2017 were up 14% over the previous year. Eurozone industrial production is growing, and at a pace that’s faster than that of the US (see chart). 

Industrial Production Graph - U.S. and Eurozone

Although price-earning ratios are above their long-term average, they are pricing in this growth, so these high stock prices are not necessarily overvalued. In fact, they may be undervalued when compared to the bond yields as represented by the green line in the chart below.

U.S. equity market valuation 1988-2017 chart

Follow the macro rather than the micro

At the end of the day, global markets are being kept in a balance between weak sentiment and positive fundamentals. Major economic factors that will move the economy forward continue to look positive, so we expect the economy to continue its path along moderate growth. While this growth rate may be affected in the short-term by policy changes, the broader long-term trend is still what guides our view. 

Uncertainties will continue to shake sentiment, and they may have a short-term effect on the market, one way or the other. As soon as the information becomes available, it will be priced into the market.  By understanding this is the way stock prices move, we’re prepared to avoid chasing the fad and can ride the broader macro-trend to our goals.  

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