Will the U.S. equity market continue in a wide, sideways range like it has been since January, or will it break out to new highs? This is a question a lot of client’s have been asking me now that the S&P 500 has traded back up to its all-time high.
Investors should be focusing on the long-term prospects for the U.S. market, rather than the short-term path. Our RBC global strategy team, and our U.S. Investment Committee think the long-term secular bull market remains intact and that a breakout to the upside should occur bringing with it new highs—and then some.
Whether it happens in coming days, weeks, or months is less relevant to long-term investors. The more important consideration is that multiple indicators are signaling that a breakout will occur at some point.
More GDP growth: Leading indicators suggest economic growth should persist for the next 12–18 months, at least. While U.S. GDP could decelerate from the torrid 4.1% pace in Q2, at this stage, RBC Capital Markets anticipates Q3 GDP will come in at 3.8%, well above trend, and should be healthy through 2019. When recession indicators start to flash, that’s a reason to cut equity exposure in portfolios. The indicators are saying we’re not at that stage of the business cycle.
Continued profit growth: RBC expects S&P 500 earnings and revenues to be robust in the second half of this year, driven by strong consumer spending and employment trends. Earnings should grow at a 20% or higher rate for the remainder of 2018, on a year-over-year basis. They seem on target to climb close to 10% y/y in 2019—a respectable rate considering the roughly 7.7 percentage point boost from tax cuts would no longer be included in the year-over-year figures.
Tariff risks manageable: While tariff risks could worsen in coming weeks, especially between the U.S. and China, the overall situation seems manageable for the U.S. economy, which is less dependent on trade than peer countries. Our economists believe there is a low probability that all of the outstanding trade disputes will ignite at once into a full-on global trade war. They anticipate the parties will ultimately negotiate trade deals for most if not all of the disputes because it is in the economic interests of the countries involved, including the U.S.
Midterm election tailwind: Nearly year-in and year-out, the U.S. equity market has followed a similar pattern surrounding midterm elections, regardless of how high the stakes have been or which party has won. The market typically pulls back or corrects at some point during the 12-month window before the midterms, and rallies the following year. (Last February, we may have seen the correction for this pre-midterm period when the S&P 500 fell 10%.) When the rally is measured from the low point 12 months before the election to the high point the following year, the move was often quite strong. By that measure, the S&P 500 rallied 25% or more in the period surrounding 19 of the last 21 midterm elections since 1934. In other words, once the dust settles the market usually sprints higher.
The overall strategy is to stay patient. Whether the U.S. equity market breaks out in coming weeks, days, or months should not be of concern to long-term investors. I think the leading economic indicators, positive corporate earnings, and the typical trading patterns surrounding midterm elections point in the direction of an ultimate breakout. While the major risk on the table— tariffs—could cause concerns and volatility from time to time, I think this is manageable for the U.S. economy and the market.
Tim