US Equities: The Case for Caution (September 2016)

We are cautious on US equity markets as we see limited near term return potential with growing downside risk as market valuations are high and the drivers that fueled earnings growth since the last recession are fading and reversing.

However, we believe staying invested at this point in the business cycle is a critical part of building long-term wealth and reaching investment objectives. We advocate a measured approach with continued exposure to US equities, but emphasize diversification across asset classes and geographies, and the use of investment products that offer equity participation with downside buffers.

Volatility Surrounding the US Election

We see the US election as a new source of market uncertainty. PE multiples are near 10 year highs and the market appears to be ignoring many near-term risks. Market complacency in the face of deteriorating earnings, increasing interest rates and an old and aging business expansion cycle, makes us cautious.

US Equities: Hope

US equity markets have increased since the election and appear to be pricing in a strong possibility that the new president and Republican government will succeed in accomplishing their tax reform and mass deregulation agenda. However, we must not lose sight of the fact that we are only four weeks into the presidency; there is no hard evidence of these successes, and it is far too soon for market participants to claim victory.

We maintain our recommendation to stay invested in US equities on the basis that the opportunity cost of sitting on the sidelines is higher than the downside risk. We caution investors begin to gradually and methodically implement downside protections in preparation for an eventual downturn in equity markets Рwith the understanding that such a downturn could be far off under an optimistic scenario.