What Do We Do Now?

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.

 January 2018

What Do We Do Now?

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:

Liquidity, Fed Policy, Earnings, and China Credit

  • The FED has indicated it intends drain some liquidity out of the banking system. This means it will sell securities and raise interest rates, in concert with while the ECB and JGB who are also slowing down their expansion. Both these actions will slow economic expansion, hopefully enough to temper inflation but not discourage optimism and growth. It’s a delicate game.
  • It is stated Fed Policy to raise rates gradually in 2018. Higher rates will discourage borrowers from overextending.
  • Corporate profits have been strong, recovering well from late 2015. Expect this growth to moderate, with earning growth closer to 6% instead of double-digit increases of 2017.

                   

  • China’s credit growth relative to its GDP is still relatively high. This indicator has varied over the past ten years, but generally higher Chinese Credit to GDP has been synonymous with stronger global growth. When China borrows, the global economy grows.  

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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.

Some Things to Consider:

  • Loan growth has declined over the past year, but consumers appear to be using their credit cards and taking on Student Loan debt.

                                                   

  • Consumer default rates are steady and much improved from the financial crisis. There are some signs of increasing credit card defaults.

                                          

  • On November 15th, 2017, a Da Vinci painting sold for $450 million to a Saudi Prince. Many consider this to be a sign of exuberance.

                                                                                                                             

  • Bitcoin trading went parabolic and traded as high as $19,000 per coin, then retraced 50% of its gain.

                                                     

  • The Canadian real estate bubble is approaching levels last seen in the US in 2007. Australia, parts of Europe and China are experiencing similar price levels. US real estate was the catalyst for the financial crisis of 2008. 
  • North Korea has a nuclear weapon, so does Iran.

Things that Go Bump in the Night

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.

What we know today and what the measures are telling us

  • US Economy: Solid, growing around 1.9%, similar to last couple of years when expectations were around 2%. 
  • Inflation: Stable with no real change in the U.S. but growing slightly in Europe, Japan and China. Global commodity and labor costs may be beginning to rise. 
  • Central Banks: US in tightening mode, Europe-Japan-China still easing, but at a reduced pace. Global money supply is still growing, making growth easier.
  • US Corporate Profits: Strong corporate profits that are growing, similar to 2012-14 but unlike conditions that preceded the 2015 market correction.
  • US Consumer Sentiment: Positive and Optimistic
  • US Employment: Low unemployment, statistically near full employment. Some employers having difficulty filling skilled jobs.
  • Interest rates: Expecting modest quarterly short-term rate increases in the US. Long-term US rates stable. Europe and Japan rates are rising but still effectively below zero. The US yield curve has not inverted, and is still positive.
  • US Stock Market: All above the 200-day average, the 50-day average, 13-week and 34-week averages. The trend is very positive.
  • Lending: Lending growth is slowing. Tighter spreads mean smaller profits for banks. Concern that some banks may loosen terms and accept lower credit borrowers. After years of declining consumer borrowing there has been some recent expansion. Auto and credit cards slightly higher default rates.
  • Global Economy: Generally positive across the Globe – China, Japan and Europe expected to post stronger growth than US as their economies catch up.

So… What Do We Do Now?

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

At Calyx, we help families protect and manage their financial resources.  We are a financial advisor and investment manager that partners with our clients to administer their financial affairs with personal attention and active risk management. 

Calyx is also advisor to charitable trusts and endowments, working with committees of faith based organizations to preserve their legacy while providing operating income. We are sensitive to the investment needs of these clients while working within the guidelines they have established to reflect their principles.

Our website is host to our “Calyx Thoughts” blog, which we update regularly to reflect our view of markets, events, and other topics of importance to our clients. We invite you to visit!

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