Why there's nothing wrong with a "just right" market

Robert M. Brookby

Robert M. Brookby
Portfolio Manager , 08/23/17

  • A “Goldilocks” environment of moderate improvement bodes well for stocks.
  • Earnings growth has improved significantly in 2017.
  • The Trump administration still has the power to directly lower regulatory barriers.
We crossed the halfway point of 2017 amid kicking and screaming in response to an eighth year of rising stock prices. The voices of disbelief have been citing risks ranging from North Korean ICBMs to disappointment in Trump’s legislative agenda, as well as discomfort with equity valuations and market leadership from a narrow band of FAANG stocks. Also, we hear more than ever before about “market structure” changes — fundamentally agnostic, blind-buying of stocks via ETFs and index funds that has broken the valuation function for professional investors.

Don't lose sight of fundamentals

It is human nature, especially when assessing the markets and economy, to try to look for drama — to view conditions as either great or terrible. The media in particular tends toward hyperbole. Fortunately, headlines are our least-used investment tool. My perspective is that the market would do well to refresh on the literary rule of three. That is, the porridge does not have to be too hot or too cold. It can be “just right.”

Among the positive forces we have seen in 2017, two stand out in my view:

  • Earnings growth has improved significantly from 2016, and we are likely to see a second consecutive quarter of double-digit growth for the first time since 2011.
  • Global economic variables have shown a greater level of positive synchronization than at almost any time since the Great Recession.
A brighter picture for corporate earnings

The “no drama” economy

Although the wind has come out of the sails of the reflation trade and Congress has been bogged down, we haven’t seen anything that has completely derailed economic growth or the corporate earnings outlook. Along with a slow and steady advance for stocks, we have seen moderate improvements in wage growth, employment, consumer confidence, and consumer spending. While moderate changes may not generate headlines, they tend to bode well for stock market performance and investor sentiment. The improvement is not dramatic, but it doesn’t have to be.

What else keeps the market’s porridge “just right?” Demographics, globalization, technology, and debt levels have combined to keep global growth slow enough so that inflation remains below central bank targets.

Just enough change in Washington

There is another factor that could have a positive influence on the equity market. Despite the failings with its legislative agenda, the Trump administration still has the power to directly lower regulatory barriers — and it is doing so. I believe business leaders are still in the process of responding positively to this, which has implications for investment and capital formation in the private sector.