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Five Reasons to Stay Invested Despite Heightened Uncertainty

Key Points
  • If markets hate uncertainty, the current combination of political and interest rate uncertainty should be upsetting to markets.

  • Five reasons to stay invested include: low chance of recession, improving growth, positive economic surprises, recovering earnings estimates, and a return of investor buying.

  • The fear of uncertainty reflects the potential threat posed by policy risks to future growth, but economic and profit growth continue to improve in the near-term and support stocks.

It is often said that markets hate uncertainty. If that is always the case, markets should be upset with the dramatic changes taking place in the political and interest rate environment.

  • In our view, global policy uncertainty is the highest it’s been in almost 40 years. It isn’t just the U.S. that is grappling with new political leadership. The upcoming G7 summit in May, where the leaders of the world’s top developed countries get together to discuss policy, will feature new leaders in four of the seven countries. Change in the leaders of most of the countries attending the summit only happened one other time, back in 1981.
  • The global trend in interest rates and inflation appears to have ended a 35 year trend. Rates have started to head higher after decades of declines. The last time they changed direction was in the early 1980s, when they began to fall. It’s been a long time since rates were rising and the impact bears watching.

The world is different now than it was in the early 1980s, but the uncertainty back then didn’t stop stocks from soon embarking on one of the longest bull markets in history. Why? Because investors’ love of growth trumps their hate of uncertainty.

Here are five reasons to stay invested despite the heightened uncertainty:

1. Low chance of recession in 2017

Prolonged bear markets are almost always associated with recessions. Historically, the difference, or spread, between short and long-term interest rates has acted as a reliable indication of a recession in the coming year for economies around the world. Usually, as the gap between short-term and long-term interest rates narrows, the higher the probability of entering a recession within the next year, as illustrated in the table below. Among many of the world’s largest economies, the chance of a recession in 2017 is currently indicated by the yield curves to be fairly low and has actually been declining for most countries over the past quarter—even as uncertainty has risen.

Yields suggest a low risk of recession in 2017

Historical time period begins: U.S. 1967, Eurozone 1970, Germany 1970, UK 1970, Sweden 1970, Mexico 2000

All yield spreads calculated as 10 year less 3 month except Mexico (5 year less 3 month).

Source: Charles Schwab, Macrobond data as of 1/11/2017

2. Global economic growth is improving

Global growth not only is unlikely to slip into recession in 2017, it is actually accelerating, led primarily by the United States and emerging markets. This week we will get the first reading on fourth quarter GDP for the United States and United Kingdom, next week will provide the GDP reports from Europe. The U.S. result may offer some further support for the rising trajectory of interest rates while U.K. GDP growth will likely offer more evidence that the economy is holding up better than expected since the vote for Brexit. China reported GDP last week at a better-than-expected 6.8% pace.

3. Stocks are tracking economic surprises

The economic data from around the world continues to exceed economists’ estimates. The Citigroup Economic Surprise Index for the world’s major developed countries, which rises when data is better than expected and falls when it is worse, has been moving higher along with the stock market. More than just an election-driven rally, stocks have been mirroring the trend in data versus expectations for the past year, rather than reacting to policy uncertainty.

Stocks have tracked better than expected economic data

Source: Charles Schwab, Bloomberg data as of 1/22/2017.

4. Earnings revisions are up

In response to improving global economic data, analysts have been raising their earnings per share expectations for global companies. While still below prior peaks, earnings estimates have been improving and helping to lift stocks.

Earnings prospects are brightening

For companies in MSCI AC World Index.
Source: Charles Schwab, Factset data as of 1/22/2017.

5. Investors are buying again

Without the aid of advice, investors often tend to chase returns. It appears that the rolling five-year return has most closely mirrored investors’ buying and selling of equity mutual funds and ETFs, as you can see in the chart below. The five-year rolling return for the global stock market has started to improve after weakening in recent years (mostly due to the drop off of 2009-10 from the five-year period), measured by the MSCI AC World Index. The return of buying by investors in recent months may be similar to the last two times the investor selling turned around, in March 2009 and May 2012, when stocks delivered strong double-digit gains over the next 6-18 months.

Chasing returns: Investors buying and selling tends to track with five-year returns

Source: Charles Schwab, Bloomberg, Investment Company Institute, data as of 1/5/2017.
Global stock market measured by MSCI AC World index.
Past performance is no guarantee of future results.

Bouts of fear may ebb and flow in the early days of the administrations of many of the world’s major countries. Should growth falter or policies that threaten near-term growth develop, markets may pullback. The fear of uncertainty reflects the potential threat posed by policy risks to future growth, but economic and profit growth continue to improve in the near-term and support stocks.

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