Broker Check

7300 Wealth Connect – 01-18

MONTHLY FINANCIAL MARKET UPDATE

The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

Running of the Bulls

The bulls took charge the day after election day, keeping the bears on the defensive throughout 2017. A GOP that controlled all three branches of government ignited early optimism among investors, who had expected easy passage of economic-friendly policies. But instead, gridlock kept investors on pins and needles until year-end, when Congress enacted a dramatic cut in the corporate tax rate and modestly shaved tax brackets for individuals.

Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC

Whatever your thoughts are about the president, investors are bipartisan. The long-term focus is on the economy and profits, i.e. the fundamentals. Investors really don’t care which party supports investor- friendly policies. Yes, there are important issues beyond the markets, and elections have consequences. But purely through the narrow prism of the market, it’s the economic fundamentals that matter.

For much of the year, improving economic fundamentals fueled bullish sentiment, sparking 71 closing daily highs for the Dow – a record (MarketWatch). Let’s review—

  1. Profit growth accelerated (Thomson Reuters).
  2. A synchronized global expansion created additional tailwinds for corporate profits.
  3. Global growth has accelerated, as noted by the IMF’s October outlook.
  4. Consumer confidence (the Conference Board) hit its best reading since late 2000.
  5. Small business confidence recorded its second-best reading in over 30 years (NFIB).
  6. The Unemployment Rate fell to 4.1% (U.S. BLS).
  7. Gross Domestic Product in the U.S. recorded two-straight quarters above 3.0% (U.S. BEA).
  8. Inflation in the U.S. remains low (Consumer Price Index—U.S. BLS).
  9. U.S. interest rates remain low, and are currently expected to rise gradually.
  10. Leading indicators put odds on a near-term recession at a low level.

Put another way, it’s the perfect receipt for last year’s impressive advance.

One more interesting aspect of last year’s rally: there was little volatility. The biggest dip of the year for the S&P 500 totaled 2.8%, the smallest since 1995’s 2.5% (LPL Research). Since 1950, the average intra-year pullback has been 13.6%. It’s a timely reminder that a modest pullback in 2018 can’t be ruled out.

A look ahead

The economic outlook heading into 2018 hasn’t been this upbeat in years, as the U.S economy finished 2017 with momentum.

Moreover, the synchronized upturn in global growth not only aids the U.S. economy, it has been a big support for earnings of U.S. multinationals, according to FactSet Research. A reduction in the corporate tax rate is set to support earnings longer term, but it’s unclear how much has been priced in by investors.

I’m never one to throw caution to the wind and perspective is in order. Figure 1 illustrates annual winning streaks for the broad-based S&P 500 Index. We’re one year away from tying the record for consecutive annual advances going back to 1947 – see Figure 1.

Figure 2 offers another comparison. It highlights the six longest bull markets since WWII and their respective advances.

The current bull market is the second longest in both longevity and performance.

By itself, the second longest bull market since WWII creates an air of caution, but bull markets don’t die of old age or enter a danger zone based only on past performance. The end of a bull market has historically correlated with the onset of a recession. Since the late 1960s, only one bear market – the 1987 Crash – did not align itself with a recession – see Figure 3.

Still, any number of events not directly tied to the economic fundamentals could spark a bout of volatility.

Might we see a selloff early in the new year? It’s possible, if investors book 2017 stock profits in tax year 2018. Following 2013’s outsized 30% gain in the S&P 500 (St. Louis Federal Reserve), shares went sideways in the first three weeks of 2014, then slid 6% over the next couple of weeks. Yet, the year finished higher.

Bigger concerns would surround the fundamentals. If inflation were to unexpectedly heat up, we could see a more aggressive Federal Reserve, one that deviates from its currently stated path of gradual rate increases. Odds of an unexpected jump in inflation are low, but keep an eye on oil prices, which have topped $60 per barrel for the first since June 2015 (St. Louis Federal Reserve).

However, a Fed that turns more aggressive in response to a spurt in economic growth is less of a concern, in my view, since a robust economy would lend added support to corporate profits. Of course, any unexpected economic slowdown would likely create a stiffer headwind for earnings and stocks.

For those who enjoy looking at probabilities, a 20%+ advance in the S&P 500 in one year does not necessarily mean we’ll see a pullback the following year.

Excluding 2017 (up 21.83% including dividends reinvested—S&P Dow Jones Indices), there have been 24 years in which the S&P 500’s annual performance has exceeded 20% (including dividends reinvested, New York School of Business S&P 500 data). The following year saw the S&P 500 rise 18 times and decline five times.

For long-term investors, it boils down to an investment plan that is rooted in a number of factors, including the economic fundamentals. Shorter term, the fundamentals may not always be positive. But discipline, patience, and investment decisions that don’t spring from an emotional response to disconcerting events have historically been the most efficient path to one’s goals.