U.S. stock indexes have continued to push to record highs, with little apparently able to throw them off course. The S&P 500® Index was up nearly 14% year-to-date¹ as of October 12, despite natural disasters and international political tensions that have created an ample “wall of worry” for stocks to climb.
If the bull market were a baseball game, we’d likely be entering or already in late innings, says Liz Ann Sonders, chief investment strategist at Schwab. But as baseball fans know, there’s still a lot of game left after the middle innings—including the possibility of extra innings.
Although there is little sign of the excess that would suggest recession risk is near, Liz Ann says she does see signs that the characteristics of the economy and market may be changing. For instance, bond yields have crept higher, international markets have performed better, and cyclical sectors such as energy and materials have outperformed—all potential signs of the latter stages of a cycle.
“We’ve seen brief periods when these shifts have occurred before, but the strength and length of the recent moves gives us reason to believe a change in character is afoot, Liz Ann says.
Economy hitting solid doubles
Another sign that we may be in late innings has been the recent acceleration in economic data, according to Liz Ann. For instance, in recent months:
The Institute for Supply Management’s (ISM) Surveys—both the manufacturing and services reports— had strong readings in September, indicating accelerating growth.²
The job market has looked healthy. Although the U.S. economy lost 33,000 jobs in September, according to the Bureau of Labor Statistics (BLS), the weakness was attributed to the impact from hurricanes, and a sharp rebound is to be expected. Less affected by the hurricanes, the unemployment rate declined to 4.2%.
There have been signs that inflation is ticking higher. The price component of both ISM surveys has increased and oil prices have moved above $50 per barrel.³ Average hourly earnings, which are released with the BLS employment report, rose 2.9% year-over-year in September. Another measure of wage growth, the Federal Reserve Bank of Atlanta’s Wage Growth Tracker, which measures median wage growth over a three-month period, showed an even more robust 3.6% growth in wages as of September.
The global economic and earnings pictures also continue to brighten. The International Monetary Fund recently upwardly revised its forecasts for global growth in 2017 and 2018 to 3.6% and 3.7%, respectively.
Potential game changers
Liz Ann says the market’s current stage is somewhat dependent on the Federal Reserve, which has slowly started to normalize monetary policy by gradually lifting interest rates and beginning to unwind its balance sheet.
“A more aggressive Fed could pose a problem for equities, but for now the Fed’s methodical approach to monetary policy tightening is keeping financial conditions loose and the bull market intact,” Liz Ann says.
Meanwhile, measures of investor sentiment are showing excess optimism, which is typically a contrarian indicator. This has been a characteristic of most of 2017, although the market has yet to experience a significant pullback. A melt-up—that is, a dramatic increase in prices as investors rush in for fear of missing out— is re-emerging as a possibility, should investors’ actions start to follow the attitudinal sentiment indicators, Liz Ann says.
“Remember though—as good as a melt-up might feel while underway, they have historically not ended well,” Liz Ann says.
What should investors consider doing now?
A market that could be in or entering late innings can provide both opportunities and risk, and investors should stay vigilant, Liz Ann says. Earnings season may propel stocks to further gains, but signs of inflation and the potential of a melt-up pose some risks. On the other hand, better global growth could help keep the game going for a while longer, she says.
So what should investors do? At this point, Liz Ann suggests making sure your strategic allocations are appropriate for your risk profile as well as your long-term goals, and make adjustments as needed via tactical rebalancing.
If you need help building a diversified portfolio, Schwab’s investor profile questionnaire can help you determine your risk profile and match it to an appropriate target asset allocation.
Regular portfolio rebalancing is also important, as it can help maintain your target allocation and prevent your portfolio from drifting into riskier territory than you intended. Rebalancing means selling positions that have become overweight in relation to the rest of your portfolio and moving the proceeds to positions that have become underweight.
It can be emotionally difficult to sell top-performing assets when the market is rallying—but over time, those assets will account for more of your portfolio, while assets that don’t perform as well will account for less. That could leave you exposed to more risk than you realize if the market environment should change. A well-balanced portfolio includes a mix of asset classes—such as stocks, fixed income investments and cash—that can help your portfolio weather different market environments.
¹ The S&P 500 index had gained 13.94% year-to-date as of Oct. 12, according to S&P Dow Jones Indices.
² According to the September 2017 Manufacturing ISM® Report On Business®, PMI® registered 60.8%, an increase of two percentage points from the August reading of 58.8%. According to the September 2017 Non-Manufacturing ISM® Report On Business®, NMI® registered 59.8%, which is 4.5 percentage points higher than the August reading of 55.3%. For both indexes, a reading above 50% indicates the sector is generally expanding; below 50% indicates the sector is generally contracting.
³ Based on West Texas Intermediate crude oil futures for November delivery, which settled at $51.37 per barrel on the New York Mercantile Exchange on Oct. 13, 2017.