With global equity markets rising for 12 consecutive months, and reaching new highs on a regular basis, there's a growing chorus arguing that a bear market might be right around the corner. We think the best way to survive a bear attack is to stand your ground. And we are standing our ground with a commitment to global equities.
The bear case really comes down to three somewhat related issues-- changes to monetary policy, equity market valuations, and excessive optimism from retail investors. Let's take these one at a time.
Despite the US Federal Reserve having raised rates three times, and likely on the way to a fourth increase in December, we believe that interest rates will remain well-behaved. Global macroeconomic factors have surprised on the upside, notably with a 3% third quarter growth in the US. Inflation continues to undershoot, reinforcing our Stuckflation theme of inflation staying stuck at low levels. The course charted by central banks is slow and steady. We believe increasing rates and the normalization of balance sheets due to improving economies should continue to be well received by markets.
There's no doubt that global equities, particularly US equities, are richly valued by the market on a price to earnings ratio basis. However, today's P/E ratio provides very little useful information to investors seeking to predict near-term price movements. Valuations can stay elevated in an environment of low interest rates, and are supported by improving fundamentals. This is reflected in solid quarterly earnings that continue to trend above expectations.
We see valuations as rich, but rational, and we don't expect a valuation correction to pull down equity markets over the near term. That said, we know that valuations matter. And we have incorporated lower than historical average returns from global equities over the longer term.
To the argument that there's too much optimism, we say watch what investors do, and not what they say. While the latest American Association of Individual Investors survey shows bullishness at an 11-month high, we note that fund flow still reflects a cautious retail investor, with bond funds attracting more than twice the net flows into equity vehicles.
Global financial markets have been comfortably numb for quite some time, with garden-variety corrections few and far between. It's rational to expect that market volatility may increase, and we could experience a normal market correction of 5% or even 10%. Even if there were a correction, we would anticipate a rebound. We don't expect that this will be the beginning of a bear market. However, we encourage investors to be prepared, and to make sure that their risk control portfolio, the portfolio of high-quality bonds and cash, is appropriately sized.