Time to go bearish on North American stocks?

Valuations in North America are leading many investors to look further afield, but that could be a mistake

Time to go bearish on North American stocks?

Valuations in North American markets are leading many Canadian investors to look further afield for investment opportunities. Underlying economic conditions in North America are improving, and just last week Statistics Canada reported that Canada’s economy had unexpectedly accelerated at a 4.5 percent pace in the second quarter. Canada's biggest banks have also reported better-than-expected third quarter results over the past couple of weeks.

Emerging markets have outperformed the U.S. and Canada over the past year and more investors are breaking out of their investment comfort zones to embrace EM, even if it does appear that the current valuations here in North America are justified. In the U.S., all three major equity indexes hit all-time highs earlier this year as did the Toronto Stock Exchange back in February. But what does it mean for investors?

With many analysts predicting that the current bull market still has some way to go, is it best to just ignore the chatter around high valuations and embrace what appears on many fronts to be a positive landscape?

“Valuations are not cheap at the moment but they are also not expensive, given the earnings growth we’ve seen, which we think will continue for the rest of 2017,” says Robert P. Browne, chief investment officer for Northern Trust Asset Management. “The current environment is allowing stocks to grow into their price-earnings ratios of 18, which doesn’t tell you anything other than stocks are somewhat expensive. But, they’re just as likely to go to 20 as back to 15 or stay where they are and let earnings catch up.”

Browne strongly believes in the merits of being fully invested and thinks some investors underestimate the cost of being bearish. If you are bearish and underweight assets, you have to be right twice, Browne explains.

“In order to achieve their goals, bearish investors have to short at the right time and then also get back in at the right time after the sell-off,” says Browne who is also co-portfolio manager of the Northern Global Tactical Asset Allocation Fund. “Very few people go two for two and the risk is you lose the power of compounding; you miss out on a year like 2013 where US equities were up over 30%.”

Browne gives the example of investor with a long-term return assumption of 6%. If they take a bearish approach in an uncertain market and miss that one year when equities are up 30%, it will be incredibly challenging to reach their target.

“The mathematical power of compounding from fully investing on a diversified basis is so rewarding that people really need to think twice about being a chronic bear,” Browne says. “That’s a very dangerous position from an asset management perspective and it is dangerous for your client portfolios.”

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