Party has Gone Long, but It’s Still On!

Party has Gone Long, but It’s Still On!

Monthly Outlook: January 2018

Happy New Year!  And who wouldn’t be in a great mood after the market returns we enjoyed in 2017?  Last year was the 9th year post-financial crisis, which makes this recovery one of the longest on record without a correction.  But as Newton showed us 300 years ago, an object in motion stays in motion until it meets an opposing force.  And so far, we just haven’t seen a big enough force to unsettle the party.  This “stays in motion” theme is, essentially, our outlook for 2018, which we’ll talk about later in this Outlook.

Let’s review 2017 markets before we look ahead.  U.S. stocks (S&P500) gained +21.7% in 2017, led primarily by technology stocks.  International stocks (FTSE All-world ex-USA) did well, too, gaining 27.4%, with Europe, Asia, and Emerging all contributing evenly.  Bonds (Barclays Aggregate) did their part to add stability but only contributed a total return of 3.5%.  So, depending on your mix of growth assets (stocks) and stability assets (bonds), one would expect 2017 portfolio returns in the mid-teens.  Not bad.  Remember that at 14%, your money doubles in about five years.

Valuations remain Sky High

Enough about 2017 – most investors are already asking, “what can I expect in 2018?!”  About two days, that’s all we get to gloat about a good year.  Any outlook ought to consider valuation metrics since they are highly correlated to long-term forward returns.  We talk about our 4 metrics repeatedly in this Outlook, (TMC/GDP, P/E10, Margin Debt, and ValueLine MAP) and guess what, they’re still sky high!  It’s just math, we can see that they are as high as every previous peak including 2007, 2000, even 1929.  But they were very high a year ago and the S&P500 still gained 21%.  These valuations levels only suggest to us that the S&P500 is likely to be where it is today, ten years from now.  Yes, you read that right – 0% returns over 10 years – but it doesn’t say how we get there.  We could see another +20% year, followed by a 40% correction, followed by years of recovery to net 0%.  Who knows?  But sky-high valuations do tell us to remain very vigilant for any changes in price trends from up to down.  Because if/when the trends change, the potential for significant downside is baked in.

Market is Not the Sun

Analysts and pundits are obsessed with looking at potential causes that might shift market trends.  I never understand why they don’t look directly at the price trend itself instead of vague clues.  The market is not the sun; we can look directly at it!  We can look at price charts all day, every day, and know with 100% certainty, whether the actual price trend is up, down, or changing.  You only need predictive clues if you need a lot of lead time to react.  With index ETFs, that we use to build iFolios, we only need minutes.  True, if you’re managing a business, or contemplating long-term real estate development, you need time.

But just for fun, let’s look at those vague economic clues and see what they might suggest for trends.  Let’s look at recession indicators.  The four that the NBER uses to formally call a recession are production, income, earnings, and sales.  We call this watching your “pies.”  All four of them are at extended levels – but have not yet rolled over.  The unemployment rate has fallen steadily from 10% in 2009 to 4.1% today and is still trending down.  An uptick to about 4.4% would be a good clue that a recession is imminent, but we don’t see it yet. The Conference Board Consumer Confidence Index is high, but still climbing.  And the Case Shiller House Price Index is very high, but not rolling over.  I think you get the point by now:  Every thing we watch, from actual price trends, to valuation metrics, to economic inputs, are all very high but not rolling over.

iFolios – not Buy & Hope Hold

The benefit of iFolios is that it is a strategy based on the discipline to follow actual price trends, to keep you invested in up-trending markets for growth, and to sell/trim holdings that are down-trending for protection.  We’re not afraid of raising cash when it’s needed.  But as we start 2018, all trends are up, we’re invested, and portfolios are growing.  Let’s go with that.