Signposts of a Mature Market Cycle

It has been a year of volatile and increasingly divergent returns for the world markets in 2018. Worldwide stocks finished the first half virtually where they started. Beneath the surface, however, returns were bifurcated with technology stocks outperforming and more defensive areas struggling under the weight of higher interest rates.

There have been a few key forces that have helped drive modest and divergent results this year. Tax cuts and increased government spending have spurred domestic growth. The current economic expansion has been one of the longest, but weakest on record, with economic growth of 2.2% per year. Fiscal stimulus applied this year is expected to boost growth to 2.9%. Consumer and business confidence has risen and companies are using proceeds from tax cuts to increase capital spending, hire new employees, repurchase stock and pay dividends, and pursue merger and acquisition opportunities.

However, trade conflicts have raised uncertainties and fueled concerns of a global trade war. Protectionist measures put in place thus far have impacted a very small percentage of the U.S. and world economy. Most experts believe a trade war promises mutual assured destruction (i.e. nobody wins) and will be avoided in the end. However, it is not clear how things will play-out and the market does not like uncertainty. Areas dependent upon global growth, such as industrial stocks and emerging markets, have been negatively impacted by trade tensions. Additionally, the Federal Reserve has adopted a more hawkish stance (favoring interest rate increases) in response to tight labor markets, rising inflation, and faster growth. As a result, bond investments and other defensive sectors have struggled.

More evidence is emerging that suggests the market and economic cycle are in a late stage. Mature bull markets are often associated with narrow market leadership, high valuations, low correlations, rising volatility, a flat/inverted yield curve, rising inflation pressure and tighter Federal Reserve policy. Many of these are evident today and resemble conditions that existed late in prior cycles.This is also a point in the market cycle where investors are tempted to chase performance and throw caution to the wind. It is impossible to consistently time the market successfully. However, given the signposts suggesting a mature bull market, we encourage clients to maintain conservative and disciplined approach that incorporates diversification to spread risk and an emphasis on fundamentals and valuations.