The stock market started off this year in a similar fashion to how it ended last year, in rally mode. The difference this year is that international stocks have been participating as well. If this international outperformance were to continue, it would be in stark contrast to the last 5 years when US stocks more than tripled the return of International stocks. The last three years of the US stock market rally has been even more fascinating because one key ingredient has been completely absent…earnings.
It’s Me, Earnings! Don’t Forget About Me!
Over the last three years, investors have seen the unemployment rate fall from 6.7% to 4.7%² and have seen the average duration of unemployment fall from 36 weeks to 25 weeks³. They have also seen the S&P 500 go from 1,831 at the start of 2014 to over 2,350 today. However, what they have not seen is an increase in S&P 500 company earnings. In fact, full year earnings for 2016 were 5% below 2013.4
It appears what has driven US stocks for the past three years has not been company fundamentals, but investor optimism itself. This has resulted in valuations of US stocks surpassing levels prior to the 2008 Financial Crisis.
There is no way to know how much investors will be willing to pay or how far they are willing to drive up US valuations. Fortunately, there are other places to look for opportunities.
What investors need to remember is that risk is not a constant factor. The price investors pay for an asset, in relation to its fundamentals, affects the risk level of that investment.