Keep calm and carry on. This is the message investors are sending after stock markets posted strong gains for the first six months of the year. Despite rising political agitation, measures of daily volatility remain close to all-time lows, marking one of the calmest periods on record.
Continued global economic growth is boosting corporate earnings expectations, especially for international developed markets. The Federal Reserve and other global central banks are unwavering in their stated intention to “normalize” monetary policy patiently and carefully given a lack of outsized inflation. As a result, a “not too hot, not too cold” Goldilocks environment persists for stock markets.
Equities are exhibiting a more favorable combination of relative value and momentum compared to bonds. Accordingly, we have maintained our emphasis on Market Risk. We remain mindful, however, that domestic stock markets are now no longer priced for above-average gains over the next market cycle. The need for diversification is therefore likely to be more pressing than in recent years.
We do not see signs that markets are concerned about an imminent economic slowdown or an overly aggressive Federal Reserve, two conditions which may foreshadow a significant correction after this year’s strong start. In the coming months, much will depend on whether and how the Federal Reserve begins to unwind its mammoth balance sheet. By the Fall, it will also be easier to predict whether Fed Chair Janet Yellen will stay for a second term or be replaced by someone more “hawkish.”
If Washington can actually deliver on its promised legislative agenda—and tax reform, in particular— corporate growth and earnings expectations may receive an additional boost. This is why the markets seem to be comfortable keeping calm and carrying on, at least for now.