Markets in Minutes: January 6, 2017
S&P 500 10 Year Treasury Gold World Ex-US US Dollar Commodities US Economy Stock Market Valuation
Markets in Minutes is intended to give our client partners and subscribers a quick and easy understanding of current market conditions. This update covers December 1 – December 30, 2017
Investor Learning: “A contrarian approach is just as foolish as a follow-the-crowd strategy. What’s required is thinking rather than polling. Unfortunately, Bertrand Russell’s observation about life in general applies with unusual force in the financial world: “Most men would rather die than think. And many do.” — Warren Buffett
“Effective money managers do not go with the flow. They are loners, by and large. They’re not joiners; they’re skeptics, cynics even. Whatever label you want to put on them, the trait they all share is that they don’t automatically trust that what the majority of people – especially the experts – are doing is necessarily correct or wise. If anything, they move in the opposite direction of the majority, or they at least seek out their own course. ” Scott Fearon – Crown Capital Management (hedge fund manager, author “Dead Companies Walking.”)
S&P 500: +0.7% since November 30, +19.4% for 2017 (+ dividends). The S&P 500 drifted higher for much of December, finishing a very strong year in the index on the back of low interest rates, solid earnings growth, tax cuts and a strengthening economy. In the near term, the S&P still appears to have gotten a bit ahead of itself – as with last month, the market is still more overbought than we’ve seen in more than a decade. This is often a precursor to a period of correction or consolidation, particularly after a strong run. Both the primary and intermediate uptrends are intact.
Bonds: The 10-year treasury yield rose 1.7% for the 2nd month in a row. In between it fell to 2.32%. The 10-Year is up 2.1% Year-to-Date. I sound like a broken record, but yields are currently low enough that long duration bonds (more than 5 years) should be examined to make sure they are in your portfolio for a specific reason. It is still a good time to compare corporate bonds with highly rated municipal bonds in both the taxable and exempt spaces.
Gold: +2.1% for the period, +12.3% for the year. Gold finished strong after an initial sell-off to start December, falling as low as -3% before starting a rally. It’s now moved into short term overbought as it attempts to break above $12.60. Volume will need to rise to confirm any breakout – a move above $12.60 that isn’t supported by rising volume is likely to fall back into the range. This may be a reasonable point to reduce bets on continued strength in gold, barring a large scale (negative) geopolitical event. For those interested, I use IAU as a proxy for Gold and the above is based on the ETF.
World Ex-US: Again, +0.8% for the month, +23.4% for 2017. A very strong year for stock markets outside the US. With valuations in the US still high, there are arguments to be made that markets outside the US will continue to outperform. I continue to view Europe and the rest of the developed world as less stable and less growth oriented than the US. I also believe emerging markets will only try to emerge as long as the US is stable and growing. When the US starts having problems, the reactions in these markets may not be worth the satisfaction in seeing higher returns today. I may be wrong about this. I’m bullish on the US, and don’t like risks in emerging economies or the social/structural risks I see in Europe. We are now entering the 2nd year where I’ve held this view. I may get some more egg on my face in 2018.
US Dollar: The Buck moved up at the start of the month and managed to get above $94 before breaking down again in late December. At this point the dollar looks likely to test the September 2017 low at $91.33 in the near term. For the year, the dollar has finished up at -10%. Dollar weakness supports of the earnings of the big US based multi-nationals by providing a currency tailwind. Price stability in the low $90s or a fall into the mid-high $80s will help Q1 earnings and broader exports.
Commodities: +4.7% for month, +11.5% for the year. Oil closed out the year with continued strength and managed to close above $60 a barrel on supply issues in the Middle East (Libya) and anticipated higher demand globally on the strength of global growth. We haven’t seen oil above $60 since 2015. Dollar weakness is also contributing to oil’s strength. My range expectations for oil in 2017 held ($40 – $60/$65). Moving into 2018, I continue to think we will see higher average oil prices vs. 2017, but I don’t see oil as holding above $60/$65 (subject to change). With prices this high, US producers are taking out the stops to get oil to market. At some point, this should offset any temporary supply constraints out of the Middle East.
Copper futures gained +7.3% for the month, +31.4% for the year. Copper is widely considered to be an indicator of economic health due to the significant role it plays in industrial manufacturing. Continued expansion in the United States and the likelihood Trump’s infrastructure agenda is likely to make it on the legislative schedule this year are near term positives.
Economy: Consumer prices rose 0.4% in November mostly as gas prices rose because of strength in oil. Prices excluding food and energy grew about 1.7% in the last 12 months. This inflation rate is still below/near the Fed mandate and should help keep rate raises gradual. Industrial production rose by 1.5% for December over the previous month and CEO’s commentary support the story of a strengthening economy. The 4th quarter numbers aren’t in yet, but I continue to expect record quarterly earnings. We’ll see. The Non-Manufacturing Index fell further from October’s 2 year high, but is still solidly in expansion. The official unemployment rate held steady at 4.1% in December, with CEO’s and suppliers complaining about the difficulty of finding qualified people. Even so, wage inflation is still below target at 2.5%. The US continues to be a mostly sweet spot: moderate inflation, rising employment, low interest rates, rising GDP and corporate earnings.
Earnings: Earnings season starts in a couple weeks and we’ll know by late February where we are. As I’ve said, I’m expecting record earnings for Q4 2017. We’ll see.
Market Valuation: Valuations have fallen as a result of the tax cut. If Q4 earnings come in strong, that may also help. From my perspective, the market is overvalued somewhere between 10%-15%, with the weight of evidence nearer 15% than 10%. In the absence of recession, this suggests that 2017 returns may have borrowed some from 2018 returns, and higher valuations moving into the start of the year support this idea. Interest rates are still low, but the Fed expects 3 raises this year. I’m fairly confident we’ll see at least 2 of those — unlike previous years, the Fed seems able to carry through with their planned raises in 2018 – -they will use the tax cuts to shield the economy from a slow-down due to higher rates. If rates rise too quickly, valuation in the market will become more problematic.
Recession Probability Indicator: The most recent reading on the RPI is 12, indicating we are not currently in recession and the investment environment is stable. CLICK HERE to learn more about the RPI.
S&P Technical Picture: The S&P is more overbought on weekly basis than we’ve seen in decades. As in the past, this continues to suggest a near term top from a technical perspective. However, as I observed in early December, corporate tax cuts combined with other positive economic data seem likely to overwhelm short term technical situation. Things still seem like they might get a bit better (prices rise) before they get worse (prices fall). Overbought situations almost always result in either pullbacks or consolidations, but as of today market fundamentals seem to be fully in control.
That being said, 2017 had record low volatility. From a statistical standpoint, that seems unlikely to continue. It seems improbable that we’d go another 12 months without a measurable correction in the market.
Thanks to corporate tax cuts, Fair Value is in the $240.00 area for S&P proxy SPY, but I would not look for the index to fall that far should a correction ensue. Barring some truly nasty surprise, pullbacks of more than 5% are probably solid opportunities for long term investors, even in the face of geopolitical events. The intermediate term and primary trends are identified by the red arrows below, Fair Value by the thick blue line. Any of these points can present reasonable entry points for index investing from a technical, if not a purely fundamental, standpoint.
SPY Chart (S&P 500 Proxy)
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