Shutterstock.com Five years into an often uneven recovery, and with stocks more volatile, are the American economy and financial markets running low on gas?
No. In fact, the U.S. is in the early stages of an extended business cycle and a secular bull market for stocks that could last another two decades.
Compared with previous cycles, this new phase could be longer and more favorable to equities, the U.S. in general, and specific investment themes. Why? Because this is the beginning of a global recycling of growth. The gigantic scale of this transition should lead to a far longer business cycle than is typical, one centered on and driven by changes in the U.S. — including a manufacturing renaissance, coupled with greater energy independence and enhanced technological independence.
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Unlike the past couple of bull markets, this recent upswing is not the result of speculative bubbles in credit, technology or real estate. Instead, it is due to progress in a wide range of sectors exemplified by technological advances, a manufacturing renaissance, supply/demand mismatches in vital industries and low barriers to entry for startups — all supported by greater business access to liquidity. Together, this will result in a period that could be called the “Era of Innovation.”
The realities of this Era of Innovation are already evident: robotics, 3-D printing, the Cloud, Big Data, mobile payment systems, advances in health-care technology and progress toward U.S. energy independence epitomize the broadest and deepest advances in innovation seen in decades. This advance not only is tangible but is generating indisputable value for companies, customers, investors and other stakeholders.
The power of this innovation, aided by accommodative central bank policies in the U.S., Japan and Europe, and cash-rich private sector balance sheets that are contributing to liquidity, is correcting the imbalances that caused the 2008 financial crisis and market plunge.
The scale of this transition should lead to a much longer business cycle than otherwise might be the case. This shift is likely to produce a long and broad cycle of equity outperformance; valuations in U.S. equities SPX, -0.47% have been steady at 16- to 17 times earnings for 2014, and that generally can be considered fair value. Return on equity in the U.S. should remain aligned with profit growth, although price-to-earnings multiples could rise consistent with increasing investor enthusiasm.
In contrast, bonds are expected to underperform; investment flows will pursue higher returns elsewhere. Emerging market assets collectively also should underperform relative to the previous cycle and in contrast to U.S. equities. Additionally, the U.S. dollar DXY, +0.21% should remain positive. As U.S. manufacturing undergoes a resurgence, there should be fewer boom-bust cycles, and demand for real assets, particularly productive land, should rise.
The recycling of global growth will not be without bumps. Spikes in market volatility,. as is currently the case, could occur, although overall volatility levels should remain low compared to recent history. Similarly, while we are in the initial stages of a prolonged bull market, equity returns are likely to vary as well. Potentially deep corrections are possible as the cycle progresses, especially given geopolitical risks.
The upshot: Five years into a possible 20-year bull market, we remain overweight equities and underweight fixed income as quickening global growth and relative valuations favor stocks over bonds. Investors should be fully diversified in such market conditions, taking advantage of growth in key sectors but remaining on the lookout for emerging systemic stresses.
The Era of Innovation potentially will be rewarding to investors whose portfolios are carefully allocated and who are suitably wary of interim risks. It definitely will be rewarding to the businesses, consumers and other beneficiaries of the technology and market breakthroughs that will dominate the next two decades and drive positive economic and financial outcomes.
Christopher Hyzy is managing director and chief investment officer at U.S. Trust, Bank of America Private Wealth Management.
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