Mid-year stock market forecast - partly sunny or partly cloudy?

Michael Aloi |

       The dog days of summer are upon us. Listening to the weather forecast, I am always interested if the meteorologist says "partly cloudy" or "partly sunny" - though both may be the same weather, it's as if one narrator has an optimistic outlook versus the other has a gloomier bias. So it may be the case with today's economy and the stock market outlook. There are signs of weakness and signs of a healthy or normal economy, let's take a look. 

        As you read this the U.S. has entered it's eleventh year of expansion, making it the longest ever. The stock market has had a remarkable year, with all major indices returning high double-digit returns. 

        Yet, evidence that all is not well is beginning to mount. The yield curve inverted, a possible signal of recession. Global trade growth and new manufacturing orders are down year-over-year. 10-Year Treasury yields are pricing in lower expectations for inflation and growth. Corporate debt is mounting. All this signals the U.S. is in a late-stage expansion. 

Source: Organization for Economic Cooperation and Development
Leading economic indicators (LEI) are designed to identify inflection points in economic growth. This decline supports the notion of easing levels of growth globally. 

 

Global growth rates are expected to be slightly lower for 2020, indicating a possible mild recession.  

 

      What does this mean for U.S. investors? There are several considerations. First, stock market growth traditionally doesn't end due to "old-age" but rather some impetus usually triggers a correction, such as a recession or a fear of a recession. Naturally, focus needs to be on the current and anticipated economy not the amount of years the current expansion has lasted. 

      Secondly, it's not all doom and gloom. A strong labor market and higher wages for workers have kept consumer confidence up.  In addition, a yield curve inversion may be typical during late cycles and has occurred twice before in 1966 and 1998 without a recession. 

 

Consumer balance sheets are healthier. Source: JP Morgan as of June 30, 2019. 

 

      Despite this mixed data, there still may be room for this horse to run. While it may be true U.S. equity market valuations are above long-term averages, it is not by much: 

Source: JP Morgan as of June 30, 2019.

 

      In addition, there are pockets of the market which have more favorable valuations, such as value stocks and international stocks. Inflation expected asset classes like Treasury inflation-protected bonds, energy stocks, commodities, and short-duration bonds for instance have typically performed very well late in the cycle: 

 

     Source: Fidelity.

 

      All this has several investing implications. First, if you haven't already, it may be time to consider re-balancing your portfolio, ensuring your stock exposure is still in line with your risk tolerance. Also, ensure your portfolio is as broadly diversified as you can reasonably tolerate. That means including more different asset classes to increase the chances that if the U.S. stock market zigs the other asset classes will zag, so to speak, like commodities. Finally, look for pockets of opportunity like value stocks and international stocks which have more favorable valuations than U.S. growth stocks. 

      As you can see, even if the forecast is for rain, a good financial advisor can help you navigate the challenges that may be ahead and put you in a position to better weather the storm and take advantage of any market opportunities. 

If you have any questions or are interested in a complimentary portfolio evaluation, please feel free to email me.