Actually, here’s why stocks can keep going up
There are still huge pockets of value especially in markets abroad
EVERYONE agrees: Stocks have had an amazing run. But can it continue? Richard Barley lays out the case below that despite the incredible increase in stock markets, there are huge pockets of value, especially abroad. Why buy stocks?
There are plenty of reasons to wonder about the longevity of the equity bull market. Given expensive markets, years of monetary-policy experimentation and geopolitical uncertainty, it is possible to concoct any number of unpleasant scenarios.
But there is also a niggling question out there: what if stocks just keep going up?
After all, any number of challenges in 2017 – the risk of a populist shock in a European election, nuclear saber-rattling from North Korea, or the fear of rising protectionism, for instance – have passed without incident or failed to unsettle markets for more than a short while.
Worriers would have gotten it wrong. Stock-market returns have raced far ahead of those on bonds. In the US, the S&P 500 has a total return of just under 20%, versus 2.5% for US Treasuries.
And the environment still looks more friendly for stocks than bonds. Global growth is broad and momentum appears good.
Earnings have recovered and are forecast to rise further around the world in 2018. US stocks may look stretched based on rising earnings multiples, a red flag in investors’ minds, but in Europe, for instance, it is earnings that are doing the heavy lifting.
Many emerging-market economies are much earlier in the cycle too. Investors might need to look further afield for returns.
Importantly, equities remain a place where investors still get paid for taking risk. The MSCI World equity risk premium has fallen, but still stands at 3.8%, above its post crisis lows and its 2007 level of 3.3%, according to Citigroup.
By contrast, low bond yields and tight corporate-credit spreads offer little room for error.
That means a scenario that is worrying bond investors – a more challenging 2018 in which inflation picks up, eroding already-skinny returns and potentially spurring further central-bank tightening – may pose less of a threat to equities. The risk pre-
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mium offers some room to absorb higher yields.
A very sharp correction in bond markets would be a problem, but so far financial conditions have remained very loose, supporting risky assets such as stocks. And while higher rates would raise the cost of new funding for companies, there has been ample opportunity to refinance at ultra-low yields.
Yet money has continued to pile into bonds. The seemingly insatiable search for yield signals a persistent imbalance between demand and supply. Equity flows, by contrast, have been more lackluster since the crisis.
It is bonds, not equities, that look more exuberant.
That turns the usual perception of the two asset classes on their head. It is hard to see how bonds produce particularly strong returns from here.
Equities might yet be the beneficiary, and continue climbing the wall of worry.