Third quarter looks profitable for global equity investors
The third quarter of 2019 is shaping up to be another profitable quarter for global equity investors. This may come as a surprise given the ongoing forecasts of impending recession by economists and investors alike throughout the summer. As we make our way towards the end of the year, we remain focused on the fundamentals (hard data instead of conjecture). Earnings forecasts for large corporations are improving modestly through 2020. Our expectation for low single-digit earnings growth through next year seems very reasonable given our outlook for modest economic growth, low unemployment, wage growth and solid consumer spending.
Global bond markets were about as volatile as stock markets this past quarter. U.S. interest rates bottomed towards the end of August before rebounding to modestly higher levels. The European Central Bank (ECB) seems intent on supporting negative interest rates, which is worrisome given the unintended consequences that negative interest rates may pose. While both Europe and the U.S. continue to support very accommodative monetary policies, we firmly believe the U.S. remains on much stronger economic footing going forward. While good values can be found by owning developed international stocks, our stock market exposure will remain much more U.S. focused. Within the U.S. market, we also believe a limited allocation to small and mid-size U.S. companies makes good sense given the strong outperformance of large blue-chip stocks over the past several years.
Given lower interest rates globally, the forward return expectation for stocks versus bonds became more pronounced in the last quarter. We are finding quality stocks that pay a dividend yield higher than what an investor would receive owning the same company’s bonds. The added value of being an owner (stockholder) – as opposed to being a lender (bondholder) – comes essentially free now in many cases. Although we firmly believe that stocks are a better value than bonds – holding all else equal, we certainly acknowledge that many of our clients benefit from having a modest allocation to high-quality bonds, particularly those clients looking to reduce risk in their portfolios. If an allocation to bonds is appropriate given your individual goals, we remain adamant that short-term bonds are the only reasonable place to allocate capital as a long-term investor. Given the uncertainty around the future of rates globally, there is no reason to own longer-term bonds, which only expose investors to additional interest-rate risk – with no incremental yield.
A persistent theme over the past few years within the U.S. stock market has been the underperformance of “value” stocks relative to “growth” stocks. While faster growing younger companies drove broader markets higher, more mature companies – many of which pay hefty dividends – were less sought-after by investors. If global interest rates remain lower for the foreseeable future, it’s quite likely that investors will once again covet higher dividend yields despite modest underlying revenue and earnings growth. In most cases, we believe it makes sense for our clients to have a mix of both growth and value stocks that are reasonably well diversified across various sectors of the economy.
Ian N. Breusch is the chief investment officer for The Sanibel Captiva Trust Company.