What May Be Ahead for Equities?

What may be ahead for equities? No one knows exactly, but here are some trends to watch and some key indicators that suggest growth opportunities.

Equities and Opportunities

The ninth anniversary of the current bull market recently occurred in March — which is the second-longest period without a 20% drop in the closing price of the S&P 500 Index.

While some market-watchers debate exactly how to measure the beginning and end of a bull market, the Invesco Diversified Dividend Fund team is focused on the profit cycle and valuation. We believe the profit cycle has moved into its latter stage and that valuations are currently extended. With this in mind, we remain focused on our fundamentally driven, bottom-up process.

Where markets are today

No one knows exactly when today’s bull market will end or when the appetite for growth and momentum stocks will abate. But we may see some key indicators that suggest growth opportunities may be harder to find. We are not macro investors, but our bottom-up research process offers insight about how the drivers of corporate earnings can change over a cycle.

This profit cycle has seen the largest profit margin expansion in 50 years despite a weaker than normal economic expansion versus previous cycles. A key question for us is how much of the expansion is structural, due to factors like better supply chain management and reduction of fixed costs, and how much is cyclical, due to factors such as corporations benefiting from lower funding costs due to historically low interest rates.

We believe the profit cycle is in its later stages as profit margins have peaked,2 the credit cycle has troughed, sales growth remains below historical recovery period levels and wage/cost pressures are rising with a tightening labor market. Further, productivity growth has averaged 0.6% since 2010 compared to 2.1% on average for each business cycle since 1948.

In the absence of greater topline and/or productivity gains, operating leverage will naturally decline in the latter stages of a cycle, and management teams will look for other ways to generate returns. We have seen this transpire with both share buybacks and M&A activity being consistent with prior peaks of 1999 and 2007.4 Though we generally applaud the return of capital to shareholders via buybacks, we don’t believe this is always the best use of capital, particularly when companies are repurchasing shares at expensive valuations.

How we’re positioned for equities for tomorrow

Our goal is to build a solid foundation for investor portfolios by adding value with less risk over a full market cycle — that includes both bull and bear markets. Our process is focused on total return, seeking to provide capital appreciation, current income and capital preservation throughout the cycle.