It’s been a strong year for equity markets, despite earlier concerns over European elections, terrorist bombings and the lack of policy from the current U.S. administration. The Standard & Poor’s 500 index is up about 10 percent for the year, but with three more months to go there’s still plenty of time for economic, fiscal or geopolitical developments to affect the markets.
Carin Pai, director of equity management, Fiduciary Trust Company International in New York, says the stock market gains this year are predominantly an earnings growth story, rather than one based on expanding price-earnings multiples.
[See: 9 of the Market’s Best Growth Stocks.]
Aside from the usual market influences like corporate earnings or economic data, market watchers say they’re keeping an eye on potential market movers such as Washington, the Federal Reserve and the global economy. Plus, outliers such as growing tensions with North Korea could cast a pall over the market.
Waiting for good news to happen. Pat O’Hare, chief market analyst for Briefing.com in Chicago, says the fourth quarter comes down to two things: “politics and a dash of the Fed. Those two forces are going to really dictate where the market goes.”
Some market commentators have attributed the stock market’s gains this year to investor expectations for tax reform, infrastructure spending, deregulation and other business-friendly changes, but no new legislation has passed. O’Hare says the contentious nature of politics between Democrats and Republicans, and within the Republican Party itself, has produced tremendous uncertainty, slowing the market’s upward momentum.
The market has priced in a lot of good news, he says, and now it’s waiting for that good news to happen. If it doesn’t, it will be difficult for stocks to keep rising, he says.
Tushar Yadava, an iShares investment strategist at BlackRock in New York, says the firm still prefers equities over fixed income but that this year’s sharp market rise leaves U.S. stocks fully valued.
Instead, he says, European, Japanese and emerging markets offer better value than the U.S., especially if global growth continues. These regions are more sensitive to global growth because many have current account surpluses and are more likely to be exporters.
[See: 9 International ETFs That Are Off the Beaten Path.]
Arnab Das, head of emerging market sovereign and macro research for Invesco in London, wrote in a research note that a synchronized global cyclical upswing will remain intact, which is good for all markets. “This would mean good growth with inflation generally below major central banks’ targets — a situation that would encourage policy normalization but without too much tightening,” Das says.
The Fed’s big question marks. In the U.S., the big questions hanging over the stock market are whether the Fed will continue raising interest rates and whom President Donald Trump will appoint as Federal Reserve chairman once Janet Yellen’s term ends in 2018. The Fed has two chances to raise rates this year, at the central bank’s September and December meetings, and it has said it wants to stop reinvesting maturing bonds that it bought during the financial crisis.
O’Hare says the bond markets believe the Fed won’t start shrinking its balance sheet or that it has much cause to raise rates soon. “That becomes an underappreciated risk, that the Fed happens to be more hawkish than currently anticipated,” O’Hare says. “If you get the Fed raising rates further, then you could create a concern — perhaps that the Fed is getting ahead of itself — and risk choking off the recovery effort too soon.”
Movements by global central banks in general are underappreciated by most investors, Yadava says. The Fed has done a pretty good job of explaining itself, he says, so most people are watching the European Central Bank. The euro remains historically high and the ECB would probably like it lower, he says. Yield curves for some southern eurozone countries are also steeper than the bank prefers. “Central banks have a lot to gain by trying to talk or influence markets with communication,” he says. “But that’s a two-way risk.”
Das says changes to the Federal Open Market Committee, which Yellen chairs, also could sway markets. The committee, which sets interest rates and establishes monetary policy, will have two seats to fill soon: Yellen’s and another committee member’s, Stanley Fischer, who plans to step down in October. “Some members of Congress would like a more hawkish, rules-based Fed, but others might want easier policy and a weak dollar to encourage investment and hiring in the manufacturing sector, as they eye the 2018 midterm elections,” Das says.
Pai suggests keeping an eye out for greater price swings after a long period of low stock market volatility. “With geopolitical risk on the rise again, it would not be surprising for the market to see and experience some volatility,” she says. “I think market sentiment has been very sanguine, even complacent, so a pullback in the market would be healthy to see.”
She says pullbacks can be buying opportunities because the general fundamental health of the stock market is strong thanks to steady earnings, consumer spending and a global economy. “If the market pulls back because of North Korea or the short-term impacts of Hurricane Harvey, it would be a good opportunity for investors,” she says.
Among the market sectors Pai favors are technology, health care and financials. Although technology has seen strong growth, she says the performance is based on earnings.
“Valuations aren’t cheap, but they’re not at elevated levels,” she says. “You need to be selective.”
In health care, she suggests investing in companies researching biotechnology and gene therapy. “Look at companies that are coming up with good drugs treating real diseases [and] that serve either a large population or focus on treatment for rare diseases,” she says.
[See: 10 Ways to Invest in Pharmaceuticals With ETFs.]
The underperforming financial sector offers opportunities. Pai says banks built a lot of capital because of financial crisis regulations, but that regulatory pressure has decreased. “They have excess capital, valuations are attractive [now] and from a historical standpoint,” she says.
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Watch For These Q4 Market Movers originally appeared on usnews.com
