Over the past few months, I have had a strong conviction that bond yields in the U.S. were going to rise due to both fundamental and technical factors. Rates have risen even faster than I would have expected given the market reaction to the U.S. Presidential election. The increase in yields has wiped out more than $1 trillion from the value of bonds globally since this summer.
Stocks, in the meantime, have been grinding higher and made new all-time highs last week in the Dow Jones Industrial Average, S&P 500 Index, and NASDAQ. I am torn on the future prospect for stocks from these levels over the next year because of conflicting factors that could impact valuations.
On the positive side for stock valuations, price-to-earnings ratios look reasonable given the current level of interest rates. Additionally, if U.S. growth prospects continue to improve, the potential for topside revenue and earnings growth exists. Reduced regulation should also allow for more investment and less costs to investors.
On the concerning side for stock prices are the issues surrounding rising interest rates and increasing wage inflation on profits. Many of the financial engineering techniques used to increase earnings over the past few years have played out or will be less impactful going forward. Additionally, the potential for protectionist trade policies is a negative for equities across the globe and the strengthening dollar also pressures multinational corporate earnings.
I see the risks and opportunities for stock price appreciation over the next year as roughly equally weighted. As a result, I am cautious on stocks at these levels but will be a buyer of dips. My overall expectation is for a 5% return for equities next year.
On Friday, the November employment report will be released. This is the last piece of key economic data prior to the Federal Reserve’s December meeting. I expect the report to show continued improvement in U.S. employment conditions. However, if the report surprises to the negative and bonds rally, I would use this as a selling opportunity for Treasury bonds.
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