One for the Record Books
The current U.S. economic expansion is now officially the longest in history, having just entered its 121st month. Shortly after the end of the second quarter, stock markets also hit all-time record highs. These milestones are juxtaposed against another less thrilling record: the current economic expansion has also been the weakest recovery since World War II.
While it is impossible to know how long the current expansion will last, economic data is flashing warning signs. Growth was already on course to slow this year as the fiscal stimulus boost associated with last year’s tax cuts has faded. The bigger drag, however, is stemming from the U.S. administration’s erratic trade policies, which has introduced further uncertainty in business investments.
History of U.S. Economic Expansions
Source: National Bureau of Economic Research & Bloomberg
Synchronized Asset Class Appreciation
All asset classes, both risky and more conservative, surprisingly, have rallied strongly in the first half of the year. This rally has occurred against a backdrop where global economic growth has slowed, trade tensions have persisted, large tech companies have faced regulatory scrutiny, and financial market distortions have deepened. As we pointed out in our first-quarter client commentary, the most obvious explanation for the appreciation of asset classes across-the-board has to do with central banks’ renewed willingness to cut interest rates, thus raising virtually all asset class valuations.
The first half of the year saw a historic policy U-turn from a well-advertised “policy normalization” to a significantly more dovish stance by the U.S. Federal Reserve, which has also been adopted by the other three major central banks (European Central Bank, Bank of Japan and People’s Bank of China). While history will tell the tale of the record-breaking U.S. economy and stock markets, it may fail to show how reliant financial markets have become on extraordinary accommodative monetary policies (i.e., zero or negative interest rates and multiple rounds of quantitative easing, or money printing) from the central banks. The table below summarizes the second-quarter and year-to-date (YTD) performance for selected indices.
Source: Bloomberg. Please see important disclosures at the end of this commentary.
“History May Not Repeat Itself, But It Often Rhymes”1
Over the past decade, financial market participants have become conditioned to associate extraordinary monetary policies and central bank liquidity with higher asset prices. This has in turn led to heightened speculation, as reflected in the surge of recent IPOs with negative earnings and the increasing number of “zombie companies” (companies whose interest expenses are larger than their earnings) in the market. The result has been tremendous asset price inflation and steep valuations as prices have well outpaced the fundamentals.
Most investors are familiar with the concept of P/E (price-to-earnings) ratios as a reflection of stock market valuations. When a stock goes up in price, it either does so as a result of improving fundamentals (i.e., increasing earnings) or based upon investor sentiment or expectations. If the latter is the case, that stock is said to appreciate because of multiple, or P/E, expansion. As illustrated in the chart below, in the current stagnant earnings growth environment, P/E ratio expansion has accounted for 92% of the year-to-date rally in the U.S. equity market. Goldman Sachs research indicates that P/E expansion has also been responsible for nearly 30% of the bull market return since March of 2009.
1 Attributed to Mark Twain
S&P 500 Price Return Attribution
Source: FactSet, Goldman Sachs Investment Research
Given the headwinds mentioned above, it is unreasonable to expect either earnings growth or multiple expansion to continue at such a pace, which suggests that investors cannot expect such strong returns over the next several years. In our opinion, central bank liquidity, low interest rates and passive investing in mega-cap U.S. growth stocks have pulled forward future investment returns. We concede that no one can accurately predict the timing of an economic recession or stock market decline. What we can do, however, is identify environments where investors face heightened risks and adjust our portfolios accordingly. If equity market valuations revert to historical norms, investors who are only relying on traditional assets to meet their goals may face a very challenging path forward. Our approach is to mix in strategies that exhibit less dependence on global economic growth in an attempt to provide more consistent returns for our clients in an otherwise uncertain world.
Please do not hesitate to contact your Morton Capital wealth advisory team if you have any questions or would like to review your portfolio or financial plan in more detail. As always, we appreciate your continued confidence and trust.
Morton Capital Investment Team
MCM recently filed an amendment to its Form ADV Brochure with the Securities and Exchange Commission to reflect some material changes since our last filing in March. Please click the link for a full copy of the amended ADV Brochure:
This commentary is mailed quarterly to our clients and friends and is for information purposes only. This document should not be taken as a recommendation, offer or solicitation to buy or sell any individual security or asset class, and should not be considered investment advice. This memorandum expresses the views of the author and are subject to change without notice. All information contained herein is current only as of the earlier of the date hereof and the date on which it is delivered by Morton Capital (MC) to the intended recipient, or such other date indicated with respect to specific information. Certain information contained herein is based on or derived from information provided by independent third-party sources. The author believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information. Any performance information contained herein is for illustrative purposes only.
Certain private investment opportunities discussed herein may only be available to eligible clients and can only be made after careful review and completion of applicable offering documents. Private investments are speculative and involve a high degree of risk.
The indices referenced in this document are provided to allow for comparison to well-known and widely recognized asset classes and asset class categories. Q2 returns shown are from 03-31-2019 through 06-28-2019 and the year-to-date returns are from 12/31/2018 through 06-28-2018. Index returns shown do not reflect the deduction of any fees or expenses. The volatility of the benchmarks may be materially different from the performance of MC. In addition, MC’s recommendations may differ significantly from the securities that comprise the benchmarks. Indices are unmanaged, and an investment cannot be made directly in an index.
Past performance is not indicative of future results. All investments involve risk including the loss of principal. Details on MC’s advisory services, fees and investment strategies, including a summary of risks surrounding the strategies, can be found in our Form ADV Part 2A. A copy may be obtained at www.adviserinfo.sec.gov.