15 May 2017 | Market Update

Climb That Wall of Worry

Executive Summary

Following new market highs at the end of 2016, investors have been fretting about the possibility of a big correction in 2017. A gamut of worries have been thrown up by the media, ranging from excessive market valuations and the length of the bull market to the unpredictable behaviour of US President Donald Trump. Whilst these are valid fears, they are mainly unfounded, as we will prove in this article. Stock markets worry about real economic data, and at present, the environment is a positive one for corporate earnings. When you add in the strength and momentum of stock markets, and the very low levels of financial stress from our Risk Matrix, it shows that it is still a very good market to be invested in. Once some of these positive indicators start to wane, we would flag this out to our investors. But for now, let’s first climb that ‘wall of worry’.


Investors have been getting antsy. After global stock markets broke out of their long-term trading range (see previous article in Mar 2017) to reach levels not seen before, worries have been compounded. Let’s examine the current top three concerns amongst investors to see whether the fears are warranted or not. We will also examine what we should be watching out for to mentally prepare us for any prospect of a rough ride ahead.

Worry #1 – Stock Market Valuations Are Very High
One of the biggest worries on everyone’s minds right now is how stock markets can continue to power forward given how expensive stocks currently are. There are many different valuation metrics, where some show a gross overvaluation of the stock market, whilst others show that the stock market is in line with long-run historical numbers. The valuation measure (cheap or expensive) will depend on the point one desires to make. To give you a perspective of where valuations currently are, see Fig 1. The charts show very different ways of measuring stock market valuations. Our view is that the current stock market valuation is around the long run average.

Fig 1: Various Methods Of Stock Market Valuations Show Different Results

However, the point we want to make is not about the most accurate way of evaluating stocks, but rather the fact that valuations have no influence on stock market returns in the short term (1-year horizon). The figure below shows low R2 values for all valuation models (R2 is a statistic that will give some information about the goodness of fit of a model). This simply shows that it is impossible to predict stock market returns based on stock market valuations. Whilst valuations may be able to explain some returns looking forward 10 years ahead, it is not significant enough from a statistical standpoint.

Fig 2: Can Cheap or Expensive Stock Market Valuation Predict Future Returns?

Thus, one should not get too hung up on stock market valuations as they do not affect returns in the short term. There are more important indicators, like our Risk Matrix and other market stress indicators, which could signal an end to the rally. Recalling our previous update in Mar 2017, where we highlighted that markets go up 70% of the time, there is thus no reason not to be invested at this point in time.

Worry #2 – This Bull Market Has Gone On For Far Too Long

Another concern many investors have is that the present bull market (which started in 2009 after the bottom of the financial crisis) has gone on for far too long without any spectacular collapse. Fig 3 shows that the present rally has gone on for 2,010 days without a 20% correction, being surpassed only by the rally which started in the late 80’s and ended with the tech bubble. As such, it is not unprecedented that markets can continue powering higher.

Fig 3: Many Investors Remain Fearful That We Have Not Had a “Bear Market” Since 2009

However, let’s not forget that we recently experienced a mini “bear market” in late 2015-2016 during the commodity/oil collapse. The event was preceded by the Greek default and China RMB devaluation. Fig 4 shows that many smaller markets in the world had suffered declines of more than 20%! The fact that the US and globally diversified stock markets were less affected is a testament to the benefits of diversification.

Fig 4: No Bear Market? Many Countries Had In Fact Suffered During the Recent Commodity/Oil Collapse!

The consolidation which occurred during this period was very healthy for stock markets – after it had risen 178% from the bottom in 2009. It also shows that the trading range (fluctuation of the market) became very tight and the market went sideways for nearly two years (Fig 5). Such movement helps the stock market release some stress and resets the bull rally. So we should not worry about how long the bull market has run but focus on things that really matter.

Fig 5: Consolidation During the Commodity/Oil Collapse Was a Healthy Breather for the Stock Market

Worry #3 – Rising Interest Rates Will Kill The Bull Market

The next major worry is how the rising interest rate environment will eventually kill off economic growth in the US and become headwinds for both the stock and bond market. First, let’s take a look at the present economic numbers around the world. Even though the Fed has raised rates three times so far, other countries still retain a benign monetary policy. It would thus take a great deal more tightening to suffocate economic activity, and thus far, other indicators are coming in above expectations as seen from the economic surprise indicators in (Fig 6).

Fig 6: Economic Data Reported Throughout The World Continues to Come In Above Expectations

As long as economic growth continues, companies continue to generate earnings. Now let’s look at another chart which we have shown a few times in the past, showing the stock market performance following interest rate hikes from the Fed. The charts show that the stock market and economy does not get bogged down until rates rise to a certain level, and only if rates rise quickly in succession, typically 4 or more hikes in a year. At the present level of tightening, it still leaves room for the stock market and economy to chug along nicely (Fig 7).

Fig 7: Quick Hikes (4 or more in a year) and Levels Of 4% Or More Typically Present Headwinds to Markets – Neither of Which is Present Now.

Worry #4 – Political Uncertainty Will Create a Market Disaster

The final worry comes from investors fretting over what Donald Trump would do, both internally in the US and externally with the rest of the world, especially his dealings with other foreign leaders. Despite the media attention, political views should not cloud reality and the more important things which matter to markets. The election of President Trump had essentially angered half the country (Democrats), and provided some confidence to Republicans that after a long time, there is renewed hope of being able to push their party’s agenda through. There has also been no honeymoon period for the new President, with many expressing strong opinions about the way Trump has been handling the job, especially with pro-Democrat media bashing his every move (Fig 8).

Fig 8: Half The Country Is Unhappy With The New President And Influences The Media and The News We Read

Looking past the politics, we can see that the environment for corporate earnings is very favourable, even without factoring in “Trumponomics” with its promises of stimulus and tax cuts. There is thus no surprise that the strong corporate earnings reported during the latest season has led to the US stock market hitting new highs (Fig 9).

Fig 9: The Current Economic Environment Favours Strong Earnings Growth

What about the rest of the world? The better global environment has also led to global companies revising forward earnings since the middle of last year, and the current reported earnings are also trending upwards. Thus the prospect of renewed stock market strength is supported by these earnings outlook, which has been unaffected by the politicking that has been going on for some time (Fig 10).

Fig 10: Global Corporate Earnings Are Also On The Rise Helped By A More Stable Global Economy


Investors have been buffeted by worries on multiple fronts as stock markets continue to grind higher. We have addressed some of the major concerns here and have shown that most of these fears are largely unfounded, although popular media and individuals will still use these as talking points to support their respective investment forecasts. Whilst there are certainly market risks (as always), these headline fears are definitely not the major concerns that they have been made out to be. There is thus an investment saying that for markets to go higher, they need to “climb a wall of worry”. Should there be excessive optimism in the world then we should be on our guard. But the present level of pessimism, coupled with the very low stress readings from our Risk Matrix, and the current positive environment for corporate earnings, together offer very little headwinds against stock markets reaching new highs, which is what we have been witnessing over the past few weeks. So be calm and stay invested!

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