Valuation Sensitivity


  • Measures of corporate activity show the global economy has been gaining momentum all year
  • U.S. tax reform remains an unknown, but does not seem to be priced into the markets yet
  • Global monetary policy seems unlikely at the moment to cause any waves


One of the most frequent questions we receive is whether the stock market is too expensive to put new money to work, or even to maintain current positions. To help address this question, we recently published a research report entitled Not Worth Being Cute. The research showed that it doesn’t pay to sell out of the equity market just because it has become “expensive.” Investors haven’t improved their returns by switching to bonds in these cases, and switching to cash produced significantly worse results. Our conclusion is that broad asset allocation changes aren’t warranted. But we have been making selective moves over the last year to account for higher valuations. Not only have we recommended reallocating from the relatively expensive U.S. equity market to developed ex-U.S. and emerging market equities, we have reduced our recommended high yield bond allocation four times in response to higher valuations.

All of this is occurring in a constructive macro environment. Measures of corporate activity, such as purchasing managers’ surveys and corporate earnings, show that the global economy has been gaining momentum all year. Capital spending has also finally picked up, which indicates increased corporate confidence. While legislative progress has been virtually absent in the United States, deregulation has boosted corporate attitudes and could pay further dividends as it moves toward the banking industry. The status of U.S. tax reform is another question we hear a lot, and we see passage as more likely next year than this. While we think investors are hoping for lowered tax rates and reform, there isn’t much firm evidence that it is priced into the stock markets. This is highlighted in the graph below, which shows the recent underperformance of high tax rate companies that should be the beneficiaries of reform.

The Federal Reserve will be undergoing significant change, starting with the likely confirmation of Jerome Powell as the new Fed Chairperson in early 2018. We have felt that President Trump would favor a Chair with a dovish bias, and expect that to influence future appointments. So the expected path of monetary policy over the next year is likely to be similar to what a Yellen-led Fed would have delivered – but the communication of the policy is where some uncertainty resides. We don’t expect major issues, but the new Fed will need to gain experience in conditioning the markets about the likely path of monetary policy. We believe that the friendly policy environment anchored by easy policy from the European Central Bank (ECB) and the Bank of Japan will facilitate this.


  • Municipal bonds have gotten relatively expensive.
  • We are awaiting new issuance for opportunities.
  • Short-date European debt remains unattractive.

U.S. Treasury short rates have risen amid multiple hikes by the Fed, while municipals yields have fallen across the entire yield curve. This has driven shorter dated municipal/Treasury ratios well below where we started the year, and below their historical averages. The Fed wants to continue raising rates in 2018, but the municipal market does not see inflation or excessive economic expansion on the horizon. Additionally, the lack of supply in the municipal market and implications of the potential tax changes may prolong the technical factors driving muni yields. We have been shortening duration in portfolios, awaiting additional supply before year end.