With the S&P 500 up 19.55% year-to-date, it’s hard to argue with equity performance in a general sense.
Plus, the economy is growing, and while there have been bouts of volatility here and there, the current climate is mostly sanguine. However, those scenarios aren’t guaranteed to last forever. In fact, they probably won’t. Market participants should prepare for challenges ahead.
“This resilient market has overcome a host of challenges, yet the current bull run is likely to be tested in coming months on several fronts. At present, the fundamental backdrop is favorable for the equity rally to continue, but challenges are out there too,” said Nationwide’s Mark Hackett in a new note.
Predictably, the Federal Reserve looms large. The central bank is in Jackson Hole, Wyoming later this month and some investors are already bracing for tapering talk and commentary on when a new rate tightening cycle could start. Even if no such tidbits emerge from the Jackson Hole confab, the Fed still has three meetings left this year, leaving plenty of opportunities for continued rate hike talk.
“Now that the U.S. is in expansion mode, the probability increases for a shift in Fed policy starting with the tapering of its asset purchase programs,” adds Hackett. “We saw a mini ‘taper tantrum’ this past March as the 10-year yield reached 1.75%, but the benchmark bond rate has since dropped meaningfully to a range of 1.2-1.3%. We would expect to see higher rates over time, particularly once tapering begins, but the insatiable appetite of investors for yield could limit the impact.”
Still, none of the aforementioned scenarios mean stocks are done for right now. Earnings growth is robust and it’s becoming clear some investors are in “there is no other asset (TINA)” mode. As Hackett notes, fixed income returns are getting harder to come by, and that could bode well for equities.
“Returns in the bond market may be even more challenging to achieve. Investors have been spoiled over the last 30 years with rising equity values and falling interest rates,” he said. “A traditional 60% equity/40% bond portfolio has generated 18% annually since the financial crisis and 11% over the past 30 years. But given current valuations in the equity and bond markets, investors should adjust their expectations when these lofty returns of the past become more difficult to repeat.”
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