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Stocks: What to Do When the Rally Is in Late Innings

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.

What you can do next

  • Don’t try to time the market—it’s time in the market that counts. Want to talk about your portfolio? Call our investment professionals at 800-355-2162.

  • Watch Schwab experts discuss other market and economic topics in the Schwab Market Snapshot.

Understanding the Federal Reserve’s Shrinking Balance Sheet
Fires, Hurricanes, and Earthquakes: What Disasters Mean For Markets
Fires, Hurricanes, and Earthquakes: What Disasters Mean For Markets

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risk including loss of principal. Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.

Diversification and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.

The Institute for Supply Management (ISM) Manufacturing Index is an index based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries.

The Institute for Supply Management (ISM) Non- Manufacturing Index is an index based on surveys of more than 400 non-manufacturing firms' purchasing and supply executives, within 60 sectors across the nation, by the Institute of Supply Management (ISM). The ISM Non-Manufacturing Index tracks economic data, like the ISM Non-Manufacturing Business Activity Index.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.


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