Review of Third Quarter
The last three months continued the trend of strong returns and stable markets. The S&P 500 rose by 4% for the quarter, which means an increase of 14% year-to-date. International stocks have performed even better, with developed market stocks increasing by 5% for the quarter and 21% year-to-date, and emerging market stocks going up by 8% for the quarter and 29% year-to-date. Bonds remained steady, rising by 1% for the quarter and 3% for the year.
Below is a table showing key economic and market indicators (as of September 30) 1 :
The overall picture is that the economy remains solid. Corporate profit announcements released in July and August again were strong, and are expected by analysts to continue to rise over the next year. Other factors, including level of household debt, amount of new housing starts, and corporate liquidity, are also positive.
We remain observant about the above average stock market valuations. As we explained in our commentary on August 10th, the reason for high values is the recent, and continued forecasted, large growth in corporate earnings. It is earnings that should, and do, drive much of stock market performance, and when earnings have high growth, stock valuations should also trend upward. Moreover, low interest rates, a weak dollar, and high stock price stability are factors that contribute to high stock market valuations.
We do want to comment on the concept of stock market “cycles” -- the concept that markets have some type of pre-destined natural flow of run-ups and declines. It is true – indeed, it’s a tautology – that all stock market run-ups will end, and at the end will be a decline in values. But the end of a “bull market”2 is not caused by some force related to time – it’s caused by specific economic events, most of which cannot be accurately predicted. The longest market run-up of almost 10 years ended because of the realization in 2000 that technology stocks were likely overvalued, while the shortest bull market over only one year stopped because of concerns in 1962 of overheated economic growth and political tensions with the USSR.
So, while this eight-year market run-up seems long in duration, there are no predictable signs that it will necessarily end soon. Moreover, let’s remember where we were as an economy when the bull market started. We had just come through the biggest economic calamity in the past 70 years, and the first few years of the run-up was merely a catch up from severe declines. Hence, while we know the current bull market will eventually end, we can’t tell you whether it will end tomorrow or in five years, and whether stocks will have risen another 5% or 50% before the end.
Bond Market Outlook
The Federal Reserve did not increase interest rates last quarter, and economists have varying opinions about whether they will increase rates again before the end of the year. However, an increase of ¼% will not likely cause any upheaval in the bond market, so we expect continued stability in bond returns. Investors should continue with short- and intermediate-term bonds, and broadly diversify their investments across different sectors.
The economy continues to show strength, and bond and stock markets have remained very stable, providing solid returns for 2017. However, we choose this point to express our continual word of caution. Volatility can occur in the markets without notice, and despite outstanding recent returns, all investors should carefully consider the risks of investing too much of their portfolio in equities. Balance and consistency are two factors that distinguish between successful and unsuccessful long-term investors.
A Personal Postscript
As we send this, the air in Oakland is choked thick with smoke from the fires to our north. We have several clients who have been evacuated from the fire zone, and my home sits within a mile of the most devastated area in Sonoma County. For all of those of you who have sustained losses, we feel for you. And for those of you from other areas who have provided support, moral or otherwise, we thank you. Despite the catastrophe, the outpouring of human kindness has been truly inspiring, and that sense of community will help the area heal over time.
(2) The definition of a bull market can vary across analyses. For this purpose, we define a bull market as continuing until there has been a decline in values over some time period of at least 20%.