The market cycle is maturing.
Over the past two years, returns have been high across stocks, with the S&P 500 nearly doubling from its lowest close during the bear market in 2009. A number of other asset classes have also recovered over the same period, with high–yield bonds and emerging–market stocks outperforming U.S. stocks. Naturally, this sort of trajectory cannot continue forever, and we expect some volatility going forward based on an aging cycle alone.
Importantly, our long-term view of the global economy remains positive. Leading economic indicators were positive throughout the winter and into the spring. Manufacturing activity has improved and total private employment increased in recent months.
Global debt issues generate uncertainty.
However, there are other factors that have caused, and may continue to cause, market volatility. Most importantly, the dynamics of excessive debt continue to form a potentially perilous backdrop for financial markets. In the past two years, massive debt burdens have shifted to the public sector from the private sector. For example, the U.S. government is negotiating how to reduce a national debt in excess of $14 trillion. These debts should be easier to manage by entities that can print money and levy taxes, but they have not gone away. Moreover, conditions in peripheral countries of Europe, including Greece and Ireland, where debt levels are well above 100% of GDP, remind us that even government powers to manage debt may prove inadequate in the worst–case scenarios.
Keep risks in mind.
In addition to global debt problems, civil unrest continues in a number of North African and Middle Eastern nations, causing political risk that has contributed to a sustained increase in oil prices, pushing gasoline prices to the neighborhood of $4 per gallon. Markets anticipate that high energy prices will have a negative effect on economic growth. Aside from this, the March earthquake and tsunami in Japan, the world’s third–largest economy, has also had an impact on global manufacturing supply chains.
In all, investors should prepare for, even expect, a transition in the investing landscape. The two–year market recovery that lifted many risk assets is giving way to a more mature phase of the expansion. Higher volatility is likely to be a feature in this stage of the market cycle.
