Following the Brexit shock in June global markets recovered strongly over the past quarter, with emerging market stocks leading the way. Prior to the recent recovery foreign and emerging markets underperformed US stocks by a wide margin in this bull market. This led many investors to wonder if they are still a valuable addition to a portfolio. Periods of alternating performance and valuation differences are exactly why we emphasize a globally diversified portfolio.
While foreign markets have begun to show more strength, they are still much more attractive than US stocks from a valuation perspective. Lower valuations equate to higher potential future returns, so we continue to expect higher future returns for foreign vs. US stocks. This is not to say that the US market does not have more room to run. Our technical indicators are still bullish and suggest we may continue to see new highs. We have to remain cautious, however, as high valuations increase the risk of significant losses on US stocks when the next bear market appears.
As election season heats up, the economy has continued to cool down. While unemployment remains low and jobs growth has been positive, the economic growth rate cycle has been in a steady decline since early 2015. This has derailed the Fed’s plans to raise rates this year as they decided again to skip a rate hike in September. Economic indicators are not pointing to an imminent recession, but the decelerated growth rate does signal vulnerability. This warrants continued caution in our investment strategy.
The current state of interest rates continues to provide challenges for bond market investing. Since bond returns are highly correlated to starting yields, we are not optimistic about future bond returns, therefore, we currently prefer high-quality bonds with short to intermediate-term maturity. This safe approach to bonds reduces return but also reduces the risk of losses if we have a sudden rise in rates. The one bright spot is these lower rates are good news for individuals looking to buy a new home or refinance an existing mortgage.
In a prolonged bull market there can be a tendency to grow complacent as positive investment returns begin to feel like the new normal. This is actually when risk is the highest and a great time to revisit both your long term goals and capacity for risk.