Monthly Markets Memo - January 2018

World Money Small.jpgby Dan Zalipski, CFA & Scott Rosenquist, CFA

The U.S. markets are off to an exceptionally strong start for 2018, with the S&P 500 hitting a string of new highs over the first several weeks.  International markets, both developed and emerging, are keeping pace thus far.  Unlike the S&P, the broad international market indices of both developed (EAFE Index) and emerging markets (MSCI EM Index) have a way to go to make new highs, as neither has exceeded the highs made prior to the financial crisis. 

Fixed-Income and other rate sensitive sectors, such as real estate, are feeling the pressure of rising interest rates and have slipped into negative territory to start the year.  Commodities have also moved higher, helped in large part by oil’s rally on the back of global growth and OPEC’s (Organization of Petroleum Exporting Countries) decision to extend production cuts to support prices.    

Investors tend to get nervous when the S&P hits a string of new highs, wondering if the latest high will become the new peak.  Adding to their concerns is the fact that the current bull market is 9 years old, with some looking to the length of the expansion as a sign that we are nearing a turning point with rough markets ahead.  While a correction (10% decline) is possible, a sustained bear market (20% decline) seems unlikely in the near-term.  It is often said that bull markets don’t die of old age.  In other words, time alone is not enough, some event or factor will ultimately contribute to the end of this bull market.

So what events or factors should investors be watching for?  Our friends at J.P. Morgan Asset Management studied and analyzed the last 10 bear markets stretching back to 1929 with some rather interesting results located in the chart below.  They have identified four common factors within the macro environment linked to bear markets.  Those factors are: a recession, a spike in commodity prices, an aggressive Federal Reserve, and extreme valuations.  Saving recession for last, let’s look at each one of these factors in today’s market environment. 

First, with the price of oil range-bound for the past year or so, it is safe to say we are not experiencing a spike in commodity prices.  Next, the Federal Reserve is in tightening mode, but compared to pace and magnitude of past tightening cycles, today’s is slow and predictable.  It is not what we would consider aggressive by any means.  An extreme valuation would be one in which the current valuation measurement, such as the trailing P/E ratio (Price-to-Earnings) runs substantially higher than the long-term average. As of the end of 2017, the S&P’s trailing P/E ratio was 23.1x compared to a 20-year average of 19.6x.  Based on those numbers, the S&P appears to be expensive with a valuation multiple higher than its historical average, but they are not what would be considered extreme.  An example of extreme valuations would be the S&P’s P/E multiple during the tech bubble of the early 2000’s, when it exceeded 30x.


Bull Markets Graphic.png


The final factor to address is recession.  Recessions are typically brought on by imbalances and excess within the economy.  To state it simply, the current risk of recession is low.  Corporate balance sheets are strong, and profits were already growing before tax reform gave them a boost, which in turn should continue to support equities.  In this current market environment, these factors in and of themselves do not seem to be indicating a recession or bear market is imminent.  It is our opinion that broad economic conditions such as low unemployment, expanding manufacturing and service sectors activity, and low interest rates are favorable to equities and should continue to support this current bull market.  

Looking Forward

Now that we are officially into the new year and off to a great start, it is a good time for investors to review their overall portfolio allocation.  Last year equity markets saw strong returns both domestically and overseas which can alter a portfolio’s composition in terms of stocks and bonds and leave an unintended overweight in certain areas of the portfolio.  When reviewing a portfolio, now may be a good time to address any upcoming liquidity needs for the year and incorporate that into the rebalancing process.  We continue to find unique pockets of the fixed income market that offer a favorable risk-reward profile relative to traditional fixed income.  An overweight to equities is still our preference, however, reducing that allocation to keep the risk profile in line with an individual’s long-term objectives is prudent. 

“I can’t change the direction of the wind, but I can adjust my sails to always reach my destination.” — Jimmy Dean

 
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies and / or opinions are revealed, this post is not intended to nor does it represent or reflect transactions or activity specific to any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from sources believed to be reliable and is not warranted to be correct, complete or accurate. Investments carry risk of loss including loss of principal.  Past performance is never a guarantee of future results.

 

Securities and Advisory services offered through LPL Financial. A registered investment advisor. Member FINRA & SIPC.

The LPL Financial representative associated with this website may discuss and/or transact securities business only with residents of the following states: IL

Website Design For Financial Services Professionals | Copyright 2018 AdvisorWebsites.com. All rights reserved