Since my last post reflecting on market behavior in the first half of the year, U.S. equities have continued their upward climb. The three most commonly quoted U.S. stock indexes – the Dow, the S&P 500, and the Nasdaq – all hit record highs at the same time last week. This is a feat that hasn’t been seen since the heyday of the tech boom in the late nineties, giving many investors déjà vu this past week and renewing concerns about the health of the stock market.
While U.S. equity valuations do appear high relative to recent historical averages, we believe it is important to view the state of the stock market in the context of the broader capital markets. Unprecedented monetary policy by central banks across the globe has created trillions of dollars’ worth of negative-yielding government bonds and has left interest rates at exceptionally low levels. Investors seeking any kind of meaningful return simply cannot find it in cash or fixed income investments.
Consequently, equities continue to appear attractive relative to most other investable asset classes. This relative attractiveness is likely a major driver of the equity market’s resilience after the January selloff and then again after the initial Brexit shock in late June, and with the Fed likely to keep the pace of further interest rate hikes exceptionally slow, we do not see a driver for this environment to change in the near future.
Another critical factor to bear in mind is that the underlying economic trends in the U.S. continue to appear broadly supportive, which also helps to backstop the stock market. Wage growth is finally picking up and the employment picture overall remains solid, which means that consumers are now more financially stable than they were in years past. Household data shows that consumers used much of the recovery to add to savings, and now that wage growth is returning and housing continues to improve, more families are willing and able to take on debt again. The fact that these trends are occurring while interest rates remain near record lows should be supportive to consumption going forward, which in turn will provide support for company earnings.
Finally, perhaps the most important contrast between today’s market and that of the late 90s may be the intangible but significant difference in investor attitude. While the tech bubble (like many bubbles) was characterized by overenthusiastic participants convinced there was nowhere to go but up, investors today are notably skeptical about the market’s prospects. Although it seems counterintuitive, this absence of blind euphoria may actually be a positive indicator for the future.
We believe it is always prudent to approach investments with a good amount of skepticism, and the fact that this behavior seems to be widespread right now may actually indicate that the market is healthier than it first appears. Correlations between stocks are decreasing and dispersion is increasing, indicating that investors are actively seeking out specific companies that appear attractive rather than passively purchasing the entire market and accepting the bad with the good. This should eventually reward prudent investors that have an eye on value and are willing to seek opportunities through the headline noise.