U.S. equities posted positive returns in the third quarter continuing a strong rally off the mid-February 2016 stock market low. The S&P 500 ended the quarter at 2168, up from 1810 on February 15. The S&P 500 posted a total return of 3.85% during the third quarter and has advanced 20% from the February 11 intra-day low. The S&P 500 ended the third quarter up 6% year-to-date; mid-cap and small-cap stocks performed even better, up 11% and 13%, respectively.
The strong advance in stock prices since February has been largely driven by 1) continued solid corporate earnings in a slow growth global economy, 2) continued low interest rates (low interest rates increase the value of companies with growing earnings and cash flow streams) and 3) investors looking for higher returns than are implied by current valuations for fixed income securities.
We expect continued equity market volatility in the fourth quarter and during 2017. Investors face a wide range of risks and uncertainties, including a weak global economic environment, rising government debt levels, declining liquidity in capital markets, widespread political uncertainty and price and valuation disparities in many asset classes that are several standard deviations from historic norms.
We remain constructive on U.S. equities looking into 2017. We believe U.S. stocks currently trade reasonably close to our appraisal of “fair value,” implying that returns for stocks going forward should generally track underlying corporate earnings, free cash flow and dividend growth. Longer term, we believe that U.S. stocks are currently priced to provide average annual total returns in a range of 6-9% over the next five to ten years.
As such, the level, trajectory and quality of corporate earnings growth are the most important factors in the current investment environment in our view, and it will be interesting to see how companies communicate with investors regarding the outlook for 2017 during third quarter earnings release conference calls over the next several weeks.
Our investment approach remains decidedly long-term in nature and focused on identifying those companies that are able to show solid business value growth in the current challenging global economic environment. We will continue to utilize periods of broad equity market weakness to add to positions in those companies that we believe offer the best combination of long-term business value growth and attractive valuation characteristics.