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Current Thinking on Valuations and the Path Forward

Investing – 10/4/2017

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The current bull market is the second longest on record in the post-WWII era, leading many market participants to wonder if there really is too much of a good thing. In the past, we have made mention of the challenges of predicting the future direction of the markets. However, not knowing where things are going doesn’t prevent us from taking stock of where things currently stand. At the surface, when we look at valuation measures and other fundamentals and compare them to historical precedents, there is a case to be made that stocks (in particular in the US) are above fair value, if not rich. That is the headline. However, there are additional insights to be gleamed by looking beyond the headline and into the data.

If history is our context, then understanding the similarities and differences between the present and the past might provide a valuable lens. This piece by our research consultant, Asset Consulting Group, compares the current environment to history. Our economy has evolved over the last 30 years, which could require that we take a more nuanced approach to some comparisons. For example, when we look at the S&P 500 Index of today, it differs in important ways from the S&P 500 Index of the past. Consider that two of the top five companies in the index, Facebook and Amazon, weren’t even in business 30 years ago. Further to that point, Information Technology has more than tripled as a weighting within the Index since 1990. So any statistical comparison of the present to the past, while informative, should not be considered gospel, but rather a tile in the mosaic that is being put together.

So where does that leave us? While we would agree that current stock valuation levels in the US are somewhere between the upper end of fair value and expensive, we maintain a neutral weight position. This reflects the fact that, while value is hard to find in the current market—be it in stocks, bonds or cash—there are positive underpinnings: earnings have improved, the labor market has been resilient, technology continues to drive improvement in profitability, and monetary policy across the world remains accommodative. Now, there is no doubt that an exogenous event could destabilize the markets, but that has always been the case. It is also true that there are some less nefarious risks out there—muted wage growth and overly aggressive monetary policy shifts to name a few. In either case, our goal is to identify the risks that we are willing to take and those which we are not, and to proactively manage your portfolios through these ups and downs.

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