In the third quarter, domestic equity market values continued to increase, reaching new, all-time highs. The strong performance was driven by the ongoing results of last year’s tax cuts, which have boosted corporate profits throughout the year. Markets continue to discount potential bad news, notably, signs of a trade war brewing with several of the United States’ largest trade partners. While an outright trade war would certainly be a negative for the global economy, markets seem to believe that a neutral or even positive outcome is more likely in the form of renegotiated trade agreements. For example, the U.S., Mexico and Canada recently agreed on a renegotiated NAFTA, with Canada seemingly capitulating to the U.S.’s aggressive negotiating tactics. A renegotiation of trade terms with Europe is likely next up, with China looming.
As the quarter turned, however, global equities sold off quickly and deeply, with markets showing signs that the decade-long bull market may be nearing an end. The end of bull market expansions is typically marked by several run-ups to record highs and “corrections” before capitulation to an inevitable recession. In times like these, we remind our clients that long-term investors should be less concerned with daily volatility and that investment returns should be measured over an economic cycle (i.e., 8-10 years). In this regard, we are generally advising clients to reduce public equity exposure to the low end of policy ranges, and to tilt equity exposure toward value over growth. As illustrated below, domestic value stocks have underperformed growth over the last ten years. This will likely reverse over the next phase of the market cycle, as growth stocks tend to outperform in bull markets, while value outperforms in bear markets.