Be Careful What You Wish For
By John Stoltzfus,
Chief Investment Strategist
Celebrate Good Times, Come On!
Appetite for stocks grew last week as economic data suggested slow growth to persist
In a New Year’s holiday abridged week stocks opened on Wall Street moving higher with several major stateside indices surging in the first four days of trading. The NASDAQ Composite led the major indices jumping 3.4% to its latest record high of 7136.6. The Dow Jones Industrial average rose 2.3% with the broad average the S&P 500 rising 2.6% on the week. Both the Dow Jones Industrials and the S&P 500 closed the week at record highs last Friday.
Mid cap stocks gained but at a lessor pace lagging larger capitalization stocks with the S&P 400 advancing to a new record high on Friday with a gain of just 1.9% for the week. Small caps posted even more modest gains relative to the large caps as the Russell 2000 and the S&P 600 advanced just 1.6% and 1.4%, respectively to attain their latest respective record highs in the same period.
For yet another week since the fourth quarter began in the year just ended it looked to us like more bull market bears and skeptics were throwing in the towel just as the annual inflow of retirement money flowed into equities.
Adding to the gains among stocks last week likely was investor money seeking to get (or achieve greater) exposure to stocks on the expectation of positive effects on corporate earnings from the tax reform bill (taking the maximum corporate tax rate to 21% from 35%) as well as the potential for further returns for shareholders as US multinationals are incentivized to repatriate earnings previously held abroad.
It’s worth noting recent reports in the press have indicated that private investors have been selling into the stock market’s gains even as institutional investors bid prices higher. However, some news stories have suggested that at least 40% of the money that has exited traditional open-ended equity mutual funds has flowed back into equities via ETFs. Such repositioning could help account for some of last week’s action as well.
“For now we see a US economy in the process of “reflating” rather than producing levels of inflation high enough to be worrisome to investors or the Federal Reserve Board.”
Foreign investors were also reported to be adding exposure to US equities as the sustainability of the US economic expansion appeared more evident.
For now equities remain our favorite asset class for goal-oriented investors so long as economic and corporate fundamentals continue to improve.
Trees Don’t Grow to the Sky
With the S&P 500 four days into the New Year having closed on Friday a little less than 9.5% away from our 2018 target of 3000 for the index, we’d suggest that investors enjoy the ride the market has provided so far this year while keeping expectations right-sized for now. Though we have yet to be approached by a taxi or Uber driver proffering stock tips or offering investment ideas we can’t help but recall that a number of former die hard skeptics and bears have adopted bull market calls just before the start of the year and now some are increasing their targets. Considering ourselves contrarians at heart, we always get a tad nervous when too many folks move to our side of the boat.
With those concerns in mind we would suggest keeping the party hats in the box and keeping an eye on where the seatbelts are. We can’t help but recall the commercial airline pilot’s perennial admonishment that “it’s okay to move around the cabin but it’s best to keep your seatbelts fastened while in your seats.”
We’re not suggesting that the bull market is ending (we think it’s “got legs”—or room and reason to move higher over time) but believe it is important for investors to take the title of Larry David’s TV show “Curb Your Enthusiasm” to heart as a handy mantra. As professional investors we always try to keep our expectations right-sized—an approach which has resulted in our being pleasantly surprised quite often since the current bull market began in March of 2009.
Should the market find a catalyst in the next few months to “take a haircut” or even just take profits we’d suggest (depending on the catalyst of course) that investors weather the choppiness that results rather than “run for the door.”
For now we see a US economy in the process of “reflating” rather than producing levels of inflation high enough to be worrisome to investors or the Federal Reserve Board. Looking ahead we see good prospects for corporate revenues and earnings to improve as more people get back to work, economies abroad rebound further, global trade continues to pick up and businesses remain prudent in raising wages and investing in their platforms. The current global environment is driven and defined by technology and globalization that foster a highly competitive environment for a myriad of businesses which further necessitates cost containment.
With that in mind we would expect that companies repatriating earnings and benefiting from a reduction in taxes will likely apply these benefits across a number of areas including buybacks, dividend hikes and some capex (investment in their operations).
Our expectations are for the Federal Reserve to remain on course with its current program to normalize interest rates at a measured and modest pace sensitive to the economy’s momentum. Last Friday’s non-farm payroll number and the release of the hourly wage growth number (see page 4 of this report for details) suggest to us that inflation remains under control allowing the Fed to let the economy reflate while not having to worry about it “overheating.”
We believe that cross border diversification of equity portfolios should remain a purposeful goal for investors as economic recoveries and nascent expansions abroad continue to take shape and gain further momentum. We continue to recommend diversification across the regions of the world with equity exposure to developed international, emerging and frontier markets. (See page 8 for our asset allocation model).
In the week ahead investors will have plenty of scheduled announcements to follow including the start of Q4 earnings season which kicks off Friday when a number of large cap banks and financial services companies report results.
Ahead of earnings at the end of the week look for news from the Consumer Electronics Show in Las Vegas starting Tuesday, Producer Prices for December on Thursday and the CPI (Consumer Price Index) for December on Friday.
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