Recent turmoil in financial markets, rising pessimism about Chinese and emerging markets growth and a renewed slump in oil prices have fueled fears that the global economic recovery is faltering. While the world economy does face several challenges, we remain convinced that the United States and Europe are on an upward growth trajectory. China is a wildcard, but while growth is slowing there, it should stabilize.
We do not foresee current equity market weakness morphing into a bear market. Bear markets typically occur against a backdrop of recessions that produce significant declines in corporate earnings. Earnings have wavered this year, but we believe this is mainly due to a profit crunch in the energy sector and the sharp rise in the U.S. dollar. The negative impact of both of these factors should fade in the coming quarters, allowing earnings to improve. Additionally, monetary policy should stay accommodative even when the Fed starts raising rates. If the Fed were only focused on the health of the U.S. economy, a rate increase would be a foregone conclusion. But overseas growth and market turmoil make the case more difficult. Unless markets are rioting, we expect the Fed will enact a 25 basis point increase this month while offering a number of dovish caveats. We think valuations are reasonable for equities, which leads us to retain a "pro-risk" investment view. Volatility is likely to remain elevated in the near-term, but we expect the bull market will resume, leading equities to reach new highs at some point over a six- to twelve month time horizon.