Each quarter we ask Gratus Capital’s investment experts Todd Jones or Marc Heilweil to weigh in on the current financial environment—addressing key issues you’ll want to have on your radar. This spring we reached out to Todd Jones, Director of Investments, to learn more about critical market trends.

Here’s what Todd is talking about this spring:

Are you concerned about current market levels being so high? If not, what are the reasons you are comfortable with staying invested in stocks?

We are eight years into the current bull market in equities, and all indications point to a continued upward bias. Yes, there are indicators that are flashing caution signs that occurred around previous equity market highs (e.g., elevated Schiller P/E, record margin debt, record profit margins, high levels of insider selling, etc).

Yet these are all known issues which are currently being discounted by the market. On the positive side of the equation, there is no denying that while the U.S. economy may be slowing down a little, other parts of the globe are counterbalancing this slowdown, particularly Europe.

This brings us to why we are comfortable with our global equity holdings at this point in the market cycle.  The primary reason we remain fully invested is due to the fact that we’ve been transitioning a portion of our equity holdings away from U.S. based companies to (primarily) European-based companies given their significant valuation and yield difference.

According to data from JP Morgan, the price-to-earnings ratio for the next 12 months on the S&P 500 sits at 17.49x while the MSCI EAFE is a more reasonable 14.86x.  On a yield basis, the S&P 500 current dividend yield is 2.01% while the MSCI EAFE yield is 3.03%.

In all, we recognize that financial markets are cyclical.  We just believe that there are a number of positive factors at work right now that lead us to believe that there is still a decent way to go until we reach the end of the current market cycle.

What are the biggest risks you see with the global stock markets right now?

It’s important to recognize that predicting what will be the catalyst for the next downturn with any degree of accuracy is next to impossible. Market turns are usually a confluence of events conspiring to sap investor confidence to a point that leads to a mass “sell” in the markets.

That being the case, the biggest risks to global stocks within this mosaic approach appear to be two-fold: (1) a rapid change in inflation expectations (which causes bond yields to rise quickly) and, (2) a rapid rise in the U.S. dollar.

The impact of either of these events would be a reduction in global liquidity. A reduction in global liquidity is a difficult environment for risk-seeking assets like stocks, as leveraged holders of equities can be forced to liquidate their holdings to meet capital calls in other parts of their portfolios. Post-2008, global central banks have broadly filled the liquidity gap with assets purchases (e.g., quantitative easing) but the efficacy of such policies is starting to be called into question now that the U.S. Federal Reserve has embarked on an interest rate-hiking paradigm.

Are you concerned with inflation or interest rates rising soon?

This is the million-dollar question as all financial assets derive their value from a risk-free rate. Our base case is that long-term U.S. interest rates remain contained and will trade within a range for the foreseeable future.

Shorter term U.S. interest rates will likely rise at a measured rate in lock step with the increases of the Federal Funds rate over time. The reason we believe longer term rates will remain contained is because economic growth in the U.S. is slowing and U.S. demographics continue to gray (leading to incremental demand for bonds).

As we’ve pointed out in the past, this “flattening” of the yield curve starts to turn problematic typically when short-term rates move higher than long-term rates. We are still a long way from this occurrence.  What would be highly problematic, however, is if intermediate/long-term rates were to rise in a rapid manner over a short period of time.

Look for the next edition of our quarterly newsletter this summer, when it’s Marc Heilweil’s turn to share his expert insight on the key financial issues of the day — and points you’ll want to consider.

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Gratus Capital is an SEC registered investment advisor. Registration with the SEC does not imply any level of skill or training. Our ADV documents are available upon request.  The opinions expressed are as of February 2017, and may change as economic conditions vary. The information provided is not intended to be relied upon as specific investment advice and is not a recommendation, offer or solicitation to buy or sell any securities.  As with any investments, past performance is not a guarantee of future results. In illiquid alternative investments, returns will be reduced by investment management fees and fund expenses. There is no guarantee that any investment strategy will achieve its objectives, generate profits or avoid losses.