U.S. stocks are entering the fourth quarter near all-time highs even as risks abound, prompting some investors to question how much farther stocks can run after a nine-year rally.
Most agree the general economic outlook looks bright, but stocks face a number of obstacles in the next three months: the Federal Reserve is expected to raise interest rates again in December; the U.S. has yet to resolve its trade disputes with China, Canada and other partners; and the coming midterm election cycle is expected to be contentious.
Many investors, though, are quick to point to robust corporate earnings, high business and consumer confidence, and an unemployment rate at its lowest level in nearly two decades as catalysts that can keep driving stocks higher.
“There are lots of reasons investors are worried,” said Erik Davidson, chief investment officer for
Private Bank. “There are a lot of things that could go wrong, but the risk of things going right is equally as likely.”
The S&P 500 climbed 7.2% in the third quarter, its best performance since the fourth quarter of 2013. The index is within 1% of its Sept. 20 all-time high and is up 9% for the year.
One of the prime reasons some investors are cautious is simply the longevity of the current bull market, which by some measures in August became the longest in history. But Mr. Davidson and others believe that as long as U.S. companies can continue posting strong profit growth, stocks can keep rising.
Corporate earnings, while still robust, are projected to slow in the third quarter from the breakneck pace of the previous two periods. Companies in the S&P 500 are expected to report a 19% jump in profits when earnings season kicks off in mid-October, according to FactSet. That is down slightly from the 25% increase they posted in the first and second quarters, which were driven partly by last year’s big tax overhaul.
The streak of strong profit growth has made valuations much more attractive than they were in January at the market’s previous peak, easing concerns among investors that stocks were far too pricey.
“Markets are at records, but valuations are reasonable because earnings have been incredibly strong,” said Richard Nackenson, portfolio manager of the Neuberger Berman Multi-Cap Opportunities Fund.
Many investors are also cautiously optimistic that stocks will be able to continue weathering the dual threat of trade tensions and higher interest rates.
As the U.S. has continued sparring with key trading partners in recent weeks, tariff threats have roiled individual stocks—particularly auto, machinery and semiconductor makers—but they have had only a marginal impact on the broader stock market. In fact, the Dow Jones Industrial Average, which is home to big multinational conglomerates and therefore more sensitive to trade talks, outperformed other U.S. indexes in the third quarter, logging a 9% gain.
“The results of tariffs just implemented haven’t found their way into the market yet,” said Jurrien Timmer, director of Global Macro at Fidelity Investments. “If there is an impact, we will see it in the earnings in the fourth quarter.”
Thus far, the trade spat has made a bigger splash in China: the benchmark Shanghai Composite is down 15% this year, while Hong Kong’s Hang Seng has dropped 7.1%.
Other political bickering in Washington, along with the coming midterm elections, has largely been dismissed as “noise” by investors who are more interested in data showing a robust pace of job creation and economic expansion.
And although investors overwhelmingly expect the Federal Reserve to raise short-term interest rates in December for the fourth time this year, there have been few signs that inflation is spiraling out of control or that the Fed will abandon its commitment to a gradual course of rate increases.
To be sure, rate-sensitive sectors of the S&P 500, like utilities and consumer staples that pay steady dividends, have underperformed this year as higher rates have made other asset classes, like government bonds, more attractive. But technology, consumer discretionary and health-care stocks have driven big gains, all rising more than 15% in 2018 in the broad stock-market index.
At the same time, confidence in the economy and the stock market remains high. Small business optimism reached its highest level on record back to 1973 in August, according to a survey by the National Federation of Independent Business. Consumers are also positive about the economy—private research group Conference Board said Tuesday that its index of consumer confidence rose to its highest level since September 2000 in August.
Investors are in turn putting more money into the stock market. According to Bank of America Merrill Lynch, its private clients’ stock allocation is near its highest point since March 2015, while their cash holdings are at their lowest point since at least 2005.
“I’m always on the lookout for bubbles, for excess,” said Mr. Davidson of Wells Fargo. “But in general, I’m just not seeing it.”
Write to Corrie Driebusch at firstname.lastname@example.org