By now you’ve probably seen a few summaries of last year’s markets and some predictions for the coming year. Of course, very few of the predictions that were published early last year got it right. Anyone who advised going all-in on the US stock market would have been ridiculed. But that’s exactly the strategy that would have worked best. Here we are after a big stock market rally in 2017. No one remembers last January and all is forgotten and forgiven after a big up year, so everyone’s a winner.
The big question is “What Do We Do Now?”
Of this year’s messages from the large firms, Fidelity’s Jurrien Timmer, is a good consensus opinion. He forecasts a positive 2018 for stocks but with lower growth and higher volatility. 2017 was as good as it gets, with an annualized growth rate of 20% and volatility of only 6%, we should expect 2018 to be closer to the longer-term market averages of 11% growth and 15% volatility. In layman’s terms, expect lower positive returns with more frequent big days, both up and down.
Contributing to this view are four important factors:
Every year comes with a long list of possible reasons for both confidence and worry. 2018 is no exception. Many of the worries won’t turn into reality, while others won’t have sufficient impact to change the trajectory of the Global economy. But there are signs that the current trajectory has risks.
There is a long list of things that could go wrong. A rumor can become reality, but until it does, it is still just rumor. Last year, the “experts” were projecting that the stock market would grind up during 2017, and maybe post a 5% gain, wary that the stock market had just taken a big jump following the election . . .The Trump Bump. Although the economy was doing fine, the social fabric after the election was torn. Remember the post-election and “Black Lives Matter” protests?
Instead of a 5% bump, the stock market last year was up well beyond anyone’s expectations. Similarly, interest rates were expected to rise to above 3% for 10-year bonds. Instead rates ended the year at 2.4%, right where they started. Because the rate rise didn’t materialize, a bank-friendly profit spread between long term loan rates and short-term borrowing rates faded, making lending less profitable.
So, what are the experts telling us now? Again, the consensus is for a 5% bump in the stock market…never mind the market has rallied almost that much in January alone! But caution should prevail, especially with the long list of things that could go wrong. Every comment about 2018 includes a caution that we could see at least one market pull-back in the 10% or greater variety. It’s just common-sense.
Fortunately, we don’t have to know how the year will end to position our portfolios properly. We actively manage, which frees us to adjust as conditions change and new information becomes available. For now, we are responding to the most current information available concerning the economy, politics, central bank intentions, investor sentiment and corporate performance. These factors tend change incrementally, and the market’s reaction can be anticipated. At Calyx, we track several economic and market measures that correlate with market extremes. This helps us to adjust our risk management strategies to protect our client’s capital.
All in all, current economic measures are good. The US and Global economic trend is showing slow and steady growth. The stock market is deliberately extending the upward trend of the past 14 months and there are no specific external actions to cause a shift to this trend.
Investors are excited about synchronized global growth and the potential earnings benefits of US tax reform. We have had one of the longest bull runs in decades complemented by low volatility. While there are no clouds on the horizon, it would be unrealistic to expect this to continue forever. We expect at least one or two market pull-backs of more than 5% in 2018, one of which may be as much as 10% during the next 12 months. Investors would view this as a healthy opportunity to take profits.
The global economy is in a sweet spot relative to employment and productivity and the US economy is gathering momentum from tax reform and deregulation. For these reasons, we do not see a recession or market crash in the near future. We believe it is more likely that a correction would rebound to even higher highs. We are preparing for a bumpier ride than last year, but will still leave us smiling by the end of December.
We entered 2017 with equal measures of optimism and uncertainty. Politics, culture, and economics all collided last year, but it has been people’s optimism about their condition and their prospects for a better future that have influenced the markets most. We have seen discipline and innovation come forward in industry, fueling increased employment and productivity. Similarly, in 2018 there is a lot to be positive about.
Market history tells us that trends persist until an event triggers an adjustment. But when the trigger event occurs, market momentum does not turn on a dime, but takes weeks to develop a new course. We monitor indicators that have strong correlation with past market extremes and we remain encouraged. Remember, patience is always the best investment.
God bless you,
Ed & Branson