U.S. stocks could decline early next year even as the American economy gains momentum.
Greg Nott, chief investment officer for Canada and senior portfolio manager at Russell Investments, says high valuations in U.S. equities give them very little room to go up.
“We’ve actually been reducing some of our exposure there,” Nott says, noting the possibility of a temporary retreat in U.S. stocks in the first quarter. “A couple percentage pullback wouldn’t surprise us, from these levels, and would actually be a bit welcome.”
The Russell 2000, S&P 500, Dow Jones Industrial Average and the Nasdaq Composite indexes all reached record highs in November as investors moved from bonds to equities, betting that Donald Trump’s decisive mandate and stimulus plan, combined with Republican control of both houses of Congress, would lead to higher growth and company performance.
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“I think the markets have got a little bit ahead of themselves in terms of how robust the amount of stimulus will end up being,” Nott says. “For the better part of 2016 we’ve been more cautious on U.S. equities and [had] more favourable outlook on European equities.”
So-called “Trump trades” have favoured health care, natural resources and financial stocks on anticipation of lighter regulation. Small cap names have also made big gains on Trump’s proposed tax cuts. As bond yields have risen, interest-rate sensitive stocks like utilities have declined.
Nott says bonds are now fairly valued and doesn’t see yields increasing further, though if they do, higher interest rates could be negative for equities.
David Lafferty, senior vice-president and chief market strategist for Natixis Global Asset Management, says equities will continue to climb as long as earnings improve, though economic growth could still be slow enough to limit company results.
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“In the U.S., the S&P trades at 18.5 times forward earnings, a little over 20 times trailing earnings. That’s not excessively high, but it’s elevated,” he says. “It doesn’t mean stocks can’t go up, it means I don’t think they can go up an enormous amount.”
U.S. gross domestic product came in higher than expected in Q3, rising an annualized 3.2 per cent and marking the fastest rate in two years.
Dan Ivascyn, chief investment officer at PIMCO, said in a company video posted last week that he doesn’t see bond yields heading up for an extended period of time. He said political uncertainty will continue to colour markets.
“In general, investors need to appreciate significant risks across markets,” he said. “You need to be very respectful of this uncertainty. What that means is be very cautious in terms of position sizing; maintain liquidity where possible. Liquidity equals portfolio flexibility, the ability therefore to take advantage of what we think will be pretty significant volatility going forward.”
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Uncertainty surrounded Italy’s economy and banking sector on Monday after voters rejected proposed constitutional reforms. The euro surprisingly rose on the news with European and U.S. stocks.
For now, Lafferty says, asset managers will go where the money goes, riding the equity gains as long as they can.
“There’s FOMO: the fear of missing out,” he says. “When stocks are languishing, nobody has that worry. But when stocks are rallying post-election and into year-end, it’s hard to imagine money managers are going to want to miss out on that.”
This article was originally published on Benefits Canada‘s companion site, Advisor.ca