Highlights
• With stock prices rising and again at or near record highs, we think it is worthwhile to consider the possible risks that could end this bull market.
• We’re not calling for a near-term end to the increase in equity prices, but we think investors should be more aware of risks as stock prices climb.
As Americans return from vacations and prepare for the change of seasons, equity markets have offered something of a surprise. After remaining range-bound since February, stocks have broken to new highs as investor optimism has been on the rise. The U.S. stock market has quadrupled since its 2009 lows, economic growth remains solid and earnings are rising.1 We remain constructive and don’t want to call for a premature end to the party. But as markets continue to rise, we think investors should start paying closer attention to possible triggers that will, at some point, start dominating market-related conversations.
Investment Conditions Are Growing Less Certain
On balance, conditions look attractive for stocks. Prices are at all-time highs, stellar earnings results are expected to continue, inflation remains contained and interest rates remain low. Consensus expectations are that the next recession won’t occur before 2020 or even later.1 These positive factors suggest that risk assets, including stocks, still have ample upside.
Beneath the surface, however, we are becoming more cautious about the economic and market outlook. The consensus may be wrong about the next recession, and inflation and rates will certainly move higher as growth continues to improve. The Federal Reserve may become too aggressive about tightening monetary policy. The U.S. political environment is growing less certain, both regarding trade policy and the overall stability of the Trump Administration. Geopolitical issues also present risks, ranging from a messy Brexit process, rising populism in Europe and elsewhere, increasing tensions between the United States and Iran, and the prospects for a diplomatic setback on the Korean peninsula.
We also see fundamental risks: improving earnings reaching their end, rising equity valuations, narrowing credit spreads and growing sovereign and corporate debt levels. While this doesn’t mean an end to the equity bull market, we think risks are worth paying attention to. We highlight three in particular:
Risk 1: The Next Recession May Be Closer Than Many Expect
Economists are notoriously poor at forecasting the timing of recessions. It could be argued that the Fed has failed to correctly forecast any recession in its history, and private economists don’t have a much better track record. The U.S. economy remains quite strong, but that is typically the case a couple of years before a recession.