“Too much of a good thing can be wonderful,” Mae West once quipped. And that’s how investors who have been overweight U.S. stocks probably feel about 2018.
Since the start of the year, the entire U.S. equity market as measured by the Schwab U.S. Broad Market ETF (SCHB) had effortlessly outperformed its global peers with a 10.50% gain as of late September. During the same period, the Vanguard Total World Stock ETF (VT) was ahead by just 4.02%. Both regionally and broadly, the U.S. equity market is alone at the top. What’s behind the move?
International markets, especially emerging markets, have been rocked by currency turmoil and trade tensions. This in turn has led to lower prices and attractive valuations. The MSCI EAFE Index recently traded at a 20% discount to its average forward price-to-earnings ratio based on data going back to 1995, according to FactSet. And if that’s not a steep enough discount to pique the interest of bargain seekers, the MSCI Japan Index traded at more than a 40% discount to its 23-year average.
Will U.S. midterm elections disrupt the stock market’s “good thing”? Historically speaking, stocks have performed well with a Republican president and divided Congress, which is a good expectation of what might happen in November. Generally, the stock market prefers political gridlock because it removes the probability of policy extremes. Whatever unfolds in this year’s midterm election, history may once again turn out to be on the stock market’s side. Not only are we entering the most favorable part of the four-year presidential cycle, but the S&P 500 is always higher one year after a midterm election than it is on the election day itself, and that’s been true since 1946.
After spending most of the summer with a yield below 3%, the yield on 10-year Treasury bonds topped that mark in early autumn. The bond trade that shorts Treasurys with maturities of 20+ years has been a winner. Inverse performing bond funds like the ProShares UltraShort 20+ Year Treasury ETF (TBT) and Direxion Daily 20+ Year Treasury Bear 3x Shares (TMV) had jumped roughly 15% and 20%, respectively, as of late September.
The trend of rising interest rates has pushed U.S. mortgage rates higher. One year ago, the rate on a 30-year fixed-rate mortgage was 3.83%, compared with a recent trading range of 4.25% to 4.75%. The housing market has cooled, and existing home sales in August were at their lowest level in two years. As a sign of dampening enthusiasm, the SPDR S&P Homebuilders ETF (XHB) was down more than 10% earlier this autumn.
Elsewhere, the three largest industry groups within the S&P 500—financials, health care and technology—have performed well and are still in an uptrend. Also, the S&P’s former telecom sector is now called the communications services sector. The Communications Services Select Sector SPDR ETF (XLC), which tracks this group, includes 23 stocks that were formerly classified in the consumer discretionary and technology sectors. High flyers including Facebook; Netflix; Twitter; and Google’s parent, Alphabet, are among XLC’s top holdings.
Looking ahead, the fourth quarter has been historically bullish. And if the trend continues, U.S. stocks will further distance themselves from the rest of the globe.