When we wrote our year end 2016 transmittal, we were convinced that tax cuts would provide significant stimulus to the US economy. We did not expect, however, that legislation would not be signed until the final business day before Christmas. Nevertheless, Congress managed to deliver a tax cut package, and in this regard, one aspect of our outlook for 2017 is applicable again for 2018. We also felt one year ago that “wild swings in asset prices would be less likely.” That proved prescient as stock market volatility fell to and remained at historic lows throughout 2017. The ebb in volatility coincided with stock indices that set all time highs on more than sixty days. Every month in 2017 witnessed the S&P 500 post a positive total return, a feat which has never occurred before. The S&P 500 also broke a record for the number of consecutive days without a 5% pullback.
Given the fanfare over the stock market’s achievements, it is natural for investors to question whether the end of the bull market is nigh. We intend to devote part of our 9th Annual Investment Symposium to this topic. Please mark your calendars: Thursday, March 1, 2018 at the new Westin in downtown Chattanooga.
The proverbial “Holy Grail” of investing has always been a single indicator that reliably predicts when the market is going to turn. While analysts and technicians search and search data bases, we affirm that no such indicator exists. Several have proven to be reliable some of the time. For example, inverted yield curves are considered by many to be reliable lead indicators of economic recessions. An inverted yield curve exists when rates on short term Treasury notes exceed those of longer term Treasuries. Inverted yield curves have frequently delivered false positives, and on those occasions when they have correctly predicted recessions, there were significant lags.
Market corrections are frequent. Most are characterized by sharp drops that occur over several months. The stock market typically recovers and eclipses previous highs in 6 – 9 months. Market corrections that reflect an economic downturn are another matter, but they tend to be rare. Those types of corrections progress into bear markets, characterized by both lengthier downturns and recovery periods. This creates the greatest challenge for investors — to correctly gauge whether a market correction will become a bear market.
At Patten & Patten, the primary guidepost on which we depend is a comprehensive examination of economic trends. In our view, current economic fundamentals are actually the primary argument for an extension of the ongoing bull market in stocks. This statement applies beyond our borders. For the first time since the end of World War II, most regions of the world are growing. This was reflected in 2017’s global stock markets. While the US indices garnered much of the attention, the S&P 500 lagged behind many international markets, including those classified as emerging.
In terms of risk factors for the coming year, we have some concern the market has become complacent with respect to the Fed’s intention to tighten monetary policy further. Tight monetary conditions have historically led to recessions. There could also be volatility associated with investors becoming acquainted with new leadership at the Fed. Additionally, the tax legislation was structured primarily as reform measures for corporations, and in that regard, it is difficult to gauge the behavioral changes such measures could engender. Most top down analyses suggest a significant increase to corporate earnings. That outcome will be essential for further gains in equity valuations.
While this letter might seem cautionary, we actually look forward to continued growth in 2018. One of the principal factors for optimism is that holiday sales were stronger than expected and the best since 2011. Additionally, the tax bill, on balance, favors consumer oriented sectors in 2018. We are hopeful for the possibility of more encouraging geo-political news in 2018 and, possibly, some bipartisan cooperation now that the tax bill has been enacted. Finally, as a parting thought, several Wall Street strategists have pointed out that the final two years of a bull market tend to be quite strong. If 2018 proves to be the final year in this powerful equity rally, let us hope that historical trends remain consistent. We wish all readers of this correspondence health, happiness and prosperity in the New Year.