The market continues to surprise on the upside with the S&P 500 index
rising 18.3% through November 30th.
Ten year U.S. Government bonds now yield 2.37%. Earnings estimates for the SPX are conservatively pegged at $131.36 for 2018 and will likely go higher with the soon to be passed GOP tax package, boosting profits on a new lower 20% corporate tax rate.
Q3 GDP came in at 3.3% last week. The Chicago Purchasing Managers Index rose
to 63.9 with a 50-level signaling expansion in the U.S. economy.
Inflation remains below the Fed target of 2% supporting the case for continued low interest rates. The Federal Reserve is expected to raise the federal funds rate by 0.25% in December and will possibly follow with 4 more similar hikes in 2018.
With an SPX close of 2642.22 we calculate an earnings/yield of 4.97% and a P/E ratio of 20.1X on a 2018 $131.36 earnings estimate. The dividend yield on the index is near 1.9% but dividends are still rising, some 10.2% in the Q3 alone.
With the imminent passage of the new tax bill in Congress expected by Christmas, earnings estimates will rise again, up to as much as $151.00 according to
UBS Wealth Management. This leaves us at a very reasonable P/E of 17.5x with an earnings yield of 5.7%. To add fuel to the fire, there are extremely low interest rates in Europe and Asia.
Easy monetary policy from the Japanese Ministry of Finance continues unabated while the EU Central Bank is just beginning the tapering its policy. Foreign capital is pouring into both the bond and stock markets in the U.S., according to the Wall Street Journal. Ten year yields in Japan are 0.03% and in Germany 0.30%. Equity prices are rising in most countries as are earnings and GDP levels. Dividends too are rising worldwide with the exception of Japan but
earnings there have grown nicely. Given low rates globally, a synchronistic rise in GDP and rising global earnings we have the perfect climate for higher equity prices.
What can go wrong?
-Inflation could begin to climb above 2% pushing Central Banks to raise rates higher and sooner than the markets currently anticipate. 2018 will most likely see 10 year yields up around the world, with 3% a likely first stop in the U.S.
-Inflation could begin to climb above 2% pushing Central Banks to raise rates higher and sooner than the markets currently anticipate. 2018 will most likely see 10 year yields up around the world, with 3% a likely first stop in the U.S.
-Both Europe and the U.S. are reducing their bloated balance sheets which have fueled this credit expansion and the bull market. A greater supply of bonds in the market place will likely lead to higher yields in the new year. Higher yields provide more competition for stocks
-Global tensions may rise to a crescendo with conflicts possible in North Korea or in the Middle East.
-OPEC and Russia have just agreed to keep on with production cuts holding oil prices steady. If, however, we have a blow up between Saudi Arabia, now led by a new brash leader and Iran's old repressive regime oil prices could spike in price, slowing global growth.
-Psychologically, this market has gone from ‘2008-2009 despair’ to slowly gaining confidence from 2010- 2017. A move towards euphoria in 2018-19 with a Goldilocks scenario continuing to unfold, may cause price spikes and sow the seeds of a serious correction.
We continue to believe stocks will outperform bonds and cash in 2018. We are on the lookout for negative signs such as an inverted yield curve, a credit crisis, or a parabolic stock market move that would signal the end of this Bull Market. In a fast changing world, we realize that stock prices at the higher end of historical ranges are always vulnerable. We are confident however that rising earnings, growing dividends and low interest rates will support those prices.
We wish you all a happy holiday season!
Communication is for informational purposes only & doesn't constitute offer to sell or a solicitation of an offer to purchase any interest in any investment vehicles managed by CFA or an associated person or entity. CFA does not accept any responsibility or liability arising from the use of this communication. No representation is being made that the information presented is accurate, current, or complete, and such information is always subject to change without notice. We do not provide legal, accounting or tax advice. Any statement regarding legal, accounting or tax matters was written about the explanation of the matters described herein & not intended or written to be relied upon by any person as definitive advice. Any discussion of U.S. tax matters contained within this communication is not intended to be used and cannot be used for avoiding penalties that may be imposed under applicable Federal, state or local tax law or recommending to another party any transaction or matter addressed.
