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Economy & Markets Insights: 3Q | 2019

By R. Crit Thomas, CFA, CAIA
Economy & Markets
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Why Don’t We Time the Market?

Why is market timing so hard? Maybe it is because the majority of the return in a bull market* straddles a bear market. Market timers risk sacrificing the most beneficial portions of a bull market even if they slightly misjudge the market peak and trough.

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 50% from the trough and is sustained for at least 6 months.
Source: Bloomberg

Stock Market Volatility

Historically a flattening in the yield curve has heralded higher stock market volatility, and vice versa. The chart below looks at the yield curve (inverted) as measured by the yield difference between the 10-year and 2-year Treasury yields. Historically, this yield curve has led volatility by three years and is indicative of the long lags between monetary policy and its impact on the economy and markets.

Yield Curve and Stock Market Volatility

*Term Spread = 10-year Treasury yield minus 2-year Treasury yield.
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 70% 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 lower earnings growth and 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

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

Closing the Mid-Cap Gap

Westfield Capital Management states that “stock prices follow earnings progress.” The chart below looks at the Russell Midcap® Index relative to the S&P 500® over the last 10 years (normalized to put them on the same scale). It indicates that relative earnings and relative price generally move together. Yet, over the last three years we have seen a gap open between relative earnings and performance. While the earnings of the Russell Midcap® Index have been slightly better than the earnings of the S&P 500® Index, the Russell Midcap® Index has significantly underperformed. Looking forward, estimates for earnings growth suggest that the relative earnings line will move higher. Closing this gap would entail relative outperformance of the Russell Midcap® Index.

Russell Midcap Index/S&P 500 Index

Source: Bloomberg


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.

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About the Author

crit thomas global market strategist

R. 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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