Let us start with the pros and cons of the current global environment:
- The U.S. has very low unemployment.
- Americans continue to spend with consumer confidence showing optimism.
- Global inflation rates remain benign.
- The Fed has turned more cautious and is indicating they will be easing interest rates.
- Overseas stock valuations are cheap in comparison to the domestic markets.
- Global economic growth is expected to slow further, but remain positive.
- Trade tensions between the U.S. and China continue.
- The U.S. stock market runup has made domestic valuations a bit high. The current forward P/E of the S&P 500 is around 17.5.
The global stock markets are in the doldrums as the world economies appear to be slowing, mostly out of trade concerns. The good news is we do not see any indications of a recession on the horizon. On the flip side, we also do not see any indications for substantive improvement in the global economies. In English, we do not expect barn-burner performance until growth accelerates.
U.S. GDP growth is forecast to remain under 2.0% for 2019 and 2020. Although consumers continue to remain in the game, businesses are noticeably backing away from capital expenditures. Developed global economies are also expected to turn in a tepid 1.5% growth rate for the next few years. With continued trade tensions concerns, the prospect of improvement in economic growth remains muted.
Global stock market valuations are another hurdle moving forward. Domestically, the S&P 500 forward P/E ratio is around 17.5, which is somewhat higher than the 20-year average of 15.7. Internationally, the forward P/E for the ACWI ex-U.S. (All Country World Index ex-US) is at 13.2 P/E ratio versus the 20-year average of 14.0. Clearly, the overseas markets have decidedly cheaper valuations.
In summary, here is how we see things:
The Fed is broadcasting its intention to lower rates due to the slowing of the economy. By doing so, they are attempting to avoid further slowing. Further, there may be some positive outcome for a U.S./China trade deal. Both events could push the stock markets (here and abroad) to new highs.
Conversely, businesses continue to cut back on capital expenditures due to continuing trade tensions. Further cuts could spread to a reduction in overall employment, and ultimately, the consumer (the biggest component of GDP) may pull back in response.
With all of this in mind, we felt a move to a more defensive posture was appropriate. As such, we have reduced the overall allocation in stocks and specifically reduced the allocation in Large Cap U.S. stocks. We remain positive moving forward, but considering all the above, a reduction in the overall risk in portfolios was prudent.