February 2018

January got off to a roaring start with the S&P 500 making record highs closing up 5.6% on the month.  Suddenly on Friday February 2, we saw the DJIA plunge 666.75 points in a session. The biggest one-day plunge since the June 2016 Brexit vote when the U.K. decided to leave the European Union. As Mark Twain famously said," history doesn't repeat itself but it often rhymes."

From the bottom of 666.69 on the SPX in March 2009. the stock market has rallied over 9 years to the January 2018 highs of 2872.87. Quite an amazing run from the panic lows of the Great Recession. On Feb 2, the U.S. ten year note yield reached 2.84% up from the 2.4% year end of 2017 and up 39 basis points over the past one year. The one-year T Bill yield is 1.87%, two years note 2.14% and thirty-year bond yield 3.09%. Notice that the 2 year ten-year spread has widened to 60 basis points which some view as a healthy sign for the economy. Spreads in high yield junk bonds hover about 350 basis points over same maturity U.S. Treasuries which is nowhere near attractive or "normalized."

So why did investors pour $100 billion into equity funds in January, the biggest monthly flow ever, according to fund tracker EPFR Global?

Friday's better than forecast jobs report saw wage growth accelerate to 2.9% year over year. Unemployment is now 4.1 %, Q 4 GDP was estimated at 2.6%.

Given last week's drop in the SPX, stocks are still up 3% after a rise of about 20% in 2017. We have not seen a 5% correction in over a year.

Earnings season is in full swing has 75% plus companies exceeding estimates and forecasting more growth ahead given the new 21% corporate tax rate.

Big Questions in Investors' Minds:

Will rates continue to rise?

Will stocks fall harder from these levels?

Are my investments safe?

Do I own the right mix of stocks, bonds, alternatives and cash

to weather any storm?

People poured money into stocks this year. They became very positive as measured by record levels of optimism recorded by Investors Intelligence, 66% Bulls and only 12.6% Bears. These levels have not been seen in 32 years.

Rates continue to rise with Fed Funds now expected to climb by 25 basis points perhaps four times this year for a total rise of 1.00%. Many experts forecast 3.00% to 3.5% for the ten-year U.S. note by year end. Bill Gross says we have entered a Bear market in bonds. Jeff Gundlach forecasts a 6% ten-year treasury yield a few years down the road.

Rates in Europe are rising as most economies in the EU improve while Quantitative Easing dwindles in Europe and ends in the U.S. Japan's QE policy continues unabated.

Stocks fear a spike in long term rates but gradually rising rates signal a growing economy. With that comes higher earnings.

Markets have gone for a record number of months with no 5-10% pullbacks, which cannot continue. A 5% correction which in past times we saw on average three times per year would bring the SPX to 2729. A 10% drop calculates to 2586. Again, the index peaked recently at 2873. 

Given record low level of volatility in 2017 which led to investor complacency, I would anticipate more 5 % plus drops in this new year.

A modest correction would reset the pervasive bullishness and give pause to the "melt up" crowd's predictions. It is time to take the market's temperature.

Trees do not grow to the sky, but there are positive earnings ahead with a rising economy and lower tax rates. S&P 500 estimates will go from $132 in 2017, to perhaps $153 in 2018 with rising margins. Preliminary estimates for 2019 are up to $165.

Fact Set has an 18x forward P/E on the market, well above the 15x five-year average. Earnings and revenues have come in above average for Q4-17.  Fact Set expects earnings growth of 13.4 % year over year. Double digit earnings growth should continue in 2018 at rates of 14.2 %-19.8% in each quarter of this year.

Risks for markets include an exogenous shock from abroad, a policy error by the FED which has a new Chairman and five new voting members. Finally, concern over a political crisis at home could upset this apple cart.

We believe it is time to review your long and short-term investment objectives to ensure your portfolio is in balance with your current needs and goals.

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