Stocks in the United States continue to move higher, with new records becoming a regular occurrence; supported by strengthening economic and earnings growth, fair valuations, and a still-accommodative Federal Reserve.Â But there are risks. A growing concern comes from across the pond as the European economy has weakened, with high unemployment, deflation concerns, and confidence being further dented by Russian sanctions.Â The continued strength in the U.S. stock market and economy is encouraging, and divergences are likely to remain heightened, but according to our friends at Cornerstone Macro Research, roughly 20% of U.S. company earnings come from the eurozone.Â We are encouraged by the recent actions by the European Central Bank (ECB), detailed below, but remain skeptical that without more substantial structural reforms, sustainable economic growth can be achieved.
More local risks are also growing. Â Several key investor sentiment indexes have again moved into territory depicting extreme optimism. Additionally, September has historically been the worst performing month for U.S. stocks, with Bespoke Investment Group reporting that since 1928 the S&P 500â€™s average September return has been -1.07%, with only 45% of Septembers showing a positive return.Â Combine that with a September Fed meeting, continuing geopolitical uncertainty, and upcoming midterm elections, and you have the ingredients for a pullback.Â
Despite these risks, we remain bullish on the U.S. stock market and would view a decent sized pullback in a positive light as it could allow sentiment to correct and the market to catch its breath.Â We believe such an event would be a buying opportunity but warn investors that if they canâ€™t handle a quick selloff in their stock portfolio, they may need to rethink their overall asset allocation.
Economy heating up
The recent round of economic releases have shown an unambiguous picture of a strengthening U.S. economy, helping to support our bullish view on stocks and showing signs of a self-sustaining expansion.Â The Job Opening and Labor Turnover Survey (JOLTS) showed a spike in job openings and an increase in the â€œquit rate;â€ the Philly Fed Business Outlook Survey posted the highest reading since 2010 for the current activity index; existing home sales and housing starts rose; and consumer confidence continues to improve.Â Adding to the positive tone, the Institute for Supply Managementâ€™s (ISM) Manufacturing Index rose to 59.0, which was the best reading since March 2011, while the new orders component spiked to 66.7, a good indicator of future growth and supportive of our theme of a capital expenditure resurgence.