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Economy & Markets Insights

By Richard "Crit" Thomas, CFA, CAIA
Economy & Markets
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winding bridge under skyscrapers

In this section, we include charts and concepts that are not necessarily thematic in nature and may, at times, even be in contrast to our own views. Some of these charts are sourced from our sub-advisors who allow for differentiated insight into a variety of asset classes on a global scale. Others, we have sourced ourselves as we find them compelling and may reflect views that are somewhat unique and may not be emphasized by the financial media.

Phase Shift

We believe we have shifted from the early cycle to mid cycle given conditions in the marketplace. During the early cycle, the monetary and fiscal stances are generally at their most accommodative. Stocks tend to run ahead of an anticipated earnings rebound, leading to P/E multiple expansion. Quite often during this phase, lower quality, more cyclical stocks outperform. During the mid cycle that we believe we are entering, monetary and fiscal stimulus typically starts to normalize and earnings growth takes over as the main market driver, causing a shift from sentiment moving stocks to fundamentals. Generally, the returns are not as robust during this phase, yet typically remain positive.

S&P 500 Index Bull Market Total Return Allocation by Quartile Since 1935

*Our definition of a bull market is met when the market has produced a minimum return of 40% from the trough and is sustained for at least 6 months.
Source: Bloomberg

The Search for Yield

When trying to understand current low Treasury yields, we explored a number of different fundamental Treasury models. The below model has been historically robust. It is important to recognize that the unique circumstances surrounding the pandemic could mean this historically derived model is currently less informative. That said, in stress testing the model with different outcomes, we find that 10-year Treasury yields are likely to remain low unless there is a significant rise in short term rates.

Yield to 10-Year Treasury Bond Model

*Based on: Core CPI, Unemployment Rate, Federal Funds Rate, 2-year Treasury yield.
Source: Bloomberg

 

We have been suggesting that the combination of near record low yields for investment grade debt, record fiscal and monetary stimulus, and economic recovery are likely to force investors further out the risk spectrum to pick up additional yield. This has been the case. With spreads nearing past lows, further price gains will likely be harder to come by, yet the absolute yield difference remains attractive and worth consideration as default risks recede with the economic recovery.

Yield to Worst

*The yield ratio is calculated by dividing the Yield to Worst of the High Yield Index by the Investment Grade Index.
Source: Bloomberg

Active Versus Passive

Note the cyclical nature of active and passive strategy returns over time. Recently, trailing five-year return observations for the S&P 500® ranked above 55% of active large-cap managers (on a gross return basis; it would be even higher net of fees). Yet note how the S&P 500® Index tended to rank higher than active funds during periods of high absolute returns. Our research suggests that absolute returns over the next five years may be more muted due to current high valuations. Now may be a good time to consider more active exposure.

S&P 500 vs Active Domestic Large Cap Funds

*Includes all non-index large cap mutual funds, including funds that have been liquidated or merged out of existence.
Returns are gross of fees.
Sources: Morningstar Direct, S&P Dow Jones Indexes

While the S&P 500® has outperformed the MSCI EAFE® and Emerging Markets Indexes over the last cycle, international stocks still represent a healthy hunting ground for active managers given the consistently high representation in the top 100 performing stocks.

The weight of the top 10 stocks in the S&P 500® reached a new high in September 2020, representing 33% of the Index’s market cap. Historically high concentration in the S&P 500® Index suggest a less diversified portfolio in a historical context. This observation is supported by the diversification ratio, which indicates that the U.S. stock index is the least diversified since the Dot-Com boom. It also means that a very small number of stocks are having an outsized influence on index returns and valuation. There may be better valuations and return opportunity in the other 490 stocks in the Index.

Perfect of Non US Stocks in Top 100/Weight of Top 100 Stocks in S&P 500

*For the following indexes: S&P 500®, MSCI EAFE®, MSCI Emerging Markets, the top 100 represents the stocks with the
highest total return in each year.

Source: Bloomberg

Valuations Around the World

As a reference, we provide valuation measures for various domestic and international indexes. The valuation range dates back to 1995.

Price to Trailing 10-Year EPS

Sources: Bloomberg, MSCI, S&P, Dow Jones Indexes

The Mid-Cap Gap

Mid cap earnings are rapidly coming back relative to large cap, pulling relative prices up with them. Historically the mid cap index has seen both earnings and price outperformance during the early stages of an economic recovery. Is it over already? We don’t believe so; more likely the Delta variant took some steam out of the rebound rally.

Russell Midcap Index/S&P 500 Index

*Normalization adjusts or rescales the values of different time series to a notionally common scale to allow for comparability.
Source: Bloomberg

Glossary of Investment Terms and Index Definitions


This commentary is for informational purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security. There is no guarantee that the information is complete or timely. Past performance is no guarantee of future results. Investing in an index is not possible. Investing involves risk, including the possible loss of principal and fluctuation of value. Please visit touchstoneinvestments.com for performance information current to the most recent month-end.

Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on the resources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.

Touchstone Funds are distributed by Touchstone Securities, Inc.*
*A registered broker-dealer and member FINRA/SIPC.

Not FDIC Insured | No Bank Guarantee | May Lose Value

crit thomas global market strategist

Richard "Crit" Thomas, CFA, CAIA

Global Market Strategist
Crit is responsible for examining and evaluating economic conditions, generating insights and providing a sharpened perspective on investment strategies for enriched portfolio construction.

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