News & Insights

As we look toward year-end, global stock markets have had a remarkable year despite tepid growth outside the U.S.

Stock markets in the U.S., Japan, and Germany are up greater than 20%.  China’s index has also risen by more than 20%, but remains well below its springtime high for 2019 and far behind its record high from early 2018.  Canada’s major index gained 15% so far this year.  Even the U.K. is up in the high-single digits despite all the commotion surrounding Brexit.  These returns are in local currency.  Therefore, U.S. investors in overseas markets have experienced lower returns because of the strength of the dollar versus other currencies.

U.S. economic growth is hovering around 2%, down from 2.9% for 2018 but well above other developed economies.  Europe experienced 0.8% growth in both the second and third quarters even as certain key economies are flirting with recession.  GDP growth in Canada and Japan is running at 1.3% with the caveat that an October 1st sales tax increase in Japan will likely lead to weak economic conditions judging from reactions to past tax increases.  Growth in India was 5%, but trends appear to be slowing.  In China, 6% GDP growth was the slowest in 27 years.  Anecdotal reports from companies doing business in China paint an even less optimistic portrait of economic conditions there.

From listening to the media, it is hard to believe the market is again flirting with all-time highs.  An “inverted” yield curve, trade policy uncertainties, overseas economic weakness, and always-present political instabilities, such as the recent attack on Saudi Arabian oilfields, should surely be enough to make anyone run for cover.

 But these concerns don’t seem to be holding back equity investors.  The forward 12-month P/E ratio for the S&P 500 is 16.8, just slightly ahead of the 5-year average of 16.5 and about 14% above the 10-year average of 14.8, a period that includes very weak earnings from 2009 and 2010.  Further, unlike a year ago, analysts aren’t expecting double-digit earnings growth.  For calendar years 2019 and 2020, earnings are expected to grow 4.3% and 5.6%, respectively.

Cautionary Signs or False Signals?

The 30-year Treasury bond recently yielded just over 2%, an all-time low.  Think about it:  investing one’s money for three decades for a negative return after taxes and inflation are factored in.  Usually long-term Treasuries perform well during periods of economic uncertainty, especially at the onset of a recession.  That’s the initial message investors perceive from this low bond yield.

 Another cautionary sign is that the Treasury yield curve is partially “inverted.”  A “normal” yield curve is upwardly-sloping, meaning that investors demand a higher yield in exchange for taking on the risks of investing over a longer period of time.  The 30-year Treasury typically yields more than the 10-year, and the 10-year more than the 2-year or a 90-day Treasury bill.  An inverted yield curve occurs when the opposite is true, that short-term Treasuries pay better than long ones.  This is rational only when the outlook is for lower interest rates as long-dated bonds will appreciate more than shorter bonds when interest rates fall.  Recently, shorter maturities like the 2-year and 5-year Treasury and the 90-day bill yielded more than a 10-year Treasury.  The 30-year bond still yields about half a percentage point more, hence the term “partial inversion.”