You can’t see the forest for the trees: It’s a saying as old as time. The thinking goes that you’re so focused on a few things in front of you that you can’t take a step back and see the bigger picture.
In 2017, the trees are U.S. equities—and make no mistake, they’re giant ones, standing tall front and center. The forest is your portfolio.
Yes, U.S. stocks are high. And their related indexes are, in some cases, higher than they’ve ever been. The problem? They’re obscuring investors from peering deeper in—from seeing beyond a short-term time horizon into what else could thrive in their portfolios. Blame it on sentiment and cycle.
All aboard the bandwagon
At Russell Investments, we believe there are three primary forces that drive financial markets: cycle, valuation and sentiment. Cycle refers to the market cycle of peaks and recessions in an economy or in a specific financial market segment. Valuation refers to the worth of an asset class, in comparison to market norms. And sentiment refers to the feeling, or attitude, of investors toward that specific portion of the market.
In the short-term—let’s say within twelve months—we believe that typical market behavior can be attributed to each of these three factors along the following percentages:
Sentiment is a powerful market driver, and we believe that it’s a primary force driving U.S. equities today. As human beings, we tend to focus on trends. If something is going up, everyone piles on. We find it hard to resist the pull of momentum and go against the grain. This is investing herding behavior at its most basic level.
In our view, cycle is another major factor in today’s market. The better things get, the more people take notice and jump on the bandwagon, and the more the cycle extends.
As a result, we believe that we are in a late-cycle, momentum-driven market—especially in the U.S., where equities have been expensive for years. Sentiment continues to push prices upward, while the business cycle breathes further life into the current market peak. But how much higher can the peaks rise, before we drop toward the valley floor?
