By Paul Quinsee via Iris.xyz

In our last Global Equity Views, three months ago, we suggested that the gap in returns between a strong U.S. stock market and weakening markets across the rest of the world was likely to narrow as international markets caught up. The opposite has happened so far. U.S. stocks enjoyed a terrific third quarter—the S&P 500 hit new record highs—while equities elsewhere struggled and emerging markets were especially soft. The long dominance of the growth style over value also continued to play out in global stock markets, with technology and internet commerce stocks especially favored by U.S. investors.

Why? Several forces are in play. First, sustained strength in the U.S. economy and corporate profits; the second-quarter earnings season was one of the strongest we can recall, and all the more impressive when we remember that we are a long way into this cycle and profits have already been growing nicely for several years. Second, the pressure exerted by a robust U.S. economy on the rest of the world via higher U.S. interest rates and a stronger dollar, which is always a sign of trouble in emerging markets. And finally, a growing list of political issues for investors to fret over (fights over trade and tariffs, the Italian budget, and, of course, Brexit) that weigh more on international markets and value stocks; these concerns encourage money to keep flowing into tested market leaders, where profits growth appears unassailable.

Looking ahead, overall our equity investors have become a little more cautious as U.S. rates march higher and the economic and profits cycles are already very long by past standards. We still think that investors should be adding to out-of-favor areas of the world’s equity markets rather than chasing the winners ever higher; the weakness in markets in early October may well be a sign that the momentum trade is ending. We continue to see sufficient growth in profits to keep markets going in the face of higher interest rates, and after the latest setback, valuations in many places look quite attractive.

TRENDS

Despite worries over interest rates and trade, our work suggests that profitability remains pretty healthy across the equity world, and we see further gains in profits next year. Earnings in the U.S. are very impressive, and although growth should cool next year as the impact of tax cuts fades, the business cycle seems in good health and standing up well to the gentle rise in interest rates so far.

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