EQM Capital LLC 2017 Market Review: “Nothing to Fear, But Fear Itself”

Posted on Jan 2, 2018

 

To paraphrase President Franklin D. Roosevelt from his 1933 inaugural address, investors had nothing to fear in 2017, except fear itself. Of course, this is easier to see now in the rear-view mirror.  For the first time in US stock market history, the S&P 500 index finished the year with positive performance in every single month and it was never down more than 5% from its high.

Sure, there was plenty to worry about during the year. The so-called “Trump Trade” was derailed by healthcare and the economic agenda failed to get traction.  The eight-year-old bull market rally, the second longest in history, is likely in its late innings.  The Fed raised interest rates 3 times during the course of the year to a range of 1.25-1.5%, the fifth such increase over the past two years.  And the geopolitical environment was plagued by unsettling factors such as terrorism and the rising nuclear threat of North Korea.

But investors shrugged off their fears and focused on the positives: a strong U.S. economy, a robust job market, corporate earnings growth, and a continued global economic recovery. The passage of a tax reform bill in December, with its cut in the corporate tax rate, was the final cherry topper for the year.

Corporate earnings continued to recover, starting off slowly but gaining momentum during the year, helped by stabilizing oil prices and a flat U.S. dollar. According to FactSet Research, earnings growth for the S&P 500 Index came in at 9.6%, the highest annual growth rate since 2011.

Moving into 2018, the market will be focused on the positive corporate earnings impact of the recent tax reform initiatives. And while it is likely that new fears and challenges will rear their ugly heads over the course of the coming year, the current market outlook remains positive and the global economy and financial markets appear poised for more gains and growth ahead.

What could go wrong?

Given all the positives for the market, U.S. stocks are fairly expensive. The Shiller P/E ratio for the S&P 500 Index stands at 31.3X, its highest level outside of 1929 and the late 1990’s.  Many market pundits fear the market may have moved too far, too fast.  Indeed, Investors Intelligence bull-bear ratio shows investors are the most bullish they have been since 1987.

Priced for perfection, the market is vulnerable to any bad news. But the hope is that lower corporate tax rates and continued strong global growth will continue to sustain corporate earnings, thus justifying higher valuation levels.

Another cause for concern is that even with the Fed raising rates, the bond yield curve has flattened significantly. An inverted yield curve, where short-term rates exceed longer term-rates, has proven a reliable predictor of past recessions. As the Fed normalizes its balance sheet and unwinds the quantitative easing (QE) put in place after the financial crisis, the expectation is that this trend will reverse and that the yield curve will steepen.

On the heels of tax reform, we remain optimistic about the near-term prospects for corporate earnings growth. Small cap earnings in particular stand to benefit from lower tax rates.  International markets remain poised for growth in the coming year as they remain at an earlier stage in the economic recovery cycle.  For the first time in 10 years, the U.K. just hiked interest rates to half a percent.

Despite all the market optimism, there are risks on the horizon which could result in heightened volatility in the coming year. We continue to remind clients to stay focused on their long-term investment goals and objectives.

Here’s wishing everyone a happy, healthy, and prosperous New Year!

Disclosure

The opinions expressed above should not be construed as investment advice. This letter is not tailored to specific investment objectives. Reliance on this information for the purpose of buying the securities to which this information relates may expose a person to significant risk. The information contained in this article is not intended to make any offer, inducement, invitation or commitment to purchase, subscribe to, provide or sell any securities, service or product or to provide any recommendations on which one should rely for financial, securities, investment or other advice or to take any decision. Readers are encouraged to seek individual advice from their personal, financial, legal and other advisers before making any investment or financial decisions or purchasing any financial, securities or investment related service or product. Information provided, whether charts or any other statements regarding market, real estate or other financial information, is obtained from sources, which we and our suppliers believe reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Nothing in this letter should be interpreted to state or imply that past results are an indication of future performance.