Contrary to most predictions, 2017 turned out to be a steady upward move for worldwide equity prices and most capital markets for that matter. As is quite often the case, all the noise did not have the impact many would have expected. Even though our year-end comments of 2016 leaned toward the positive side, we’re not sure we would have predicted as robust a year as it turned out to be. As we now enter the ninth year of a strong rebound in asset prices, the question of how much longer this can last remains front and center.
As for the past, 2017 was a positive for most major asset classes. The big story—and one we at NNP have been waiting for—was a rotation from the U.S. equity markets to overseas. In fact, both the emerging and developed overseas equity markets outperformed the U.S. Outperformance has not happened in quite some time, and we would guess this trend is likely to continue. On the other hand, traditional fixed-income markets remained muted—not surprising considering how low rates have been. In fact, looking back at the last five years, the bond market (as measured by the Bloomberg Aggregate Index) has lost much of its luster. So, now what?
The case for further gains.
Since 2009, we have repeated the mantra that low interest rates, low inflation and low taxes provide a solid foundation for equity prices. Even though much has changed since 2009, these key building blocks remain in place. In fact, we now have even lower taxes as we enter 2018. Finally, as we have also repeatedly mentioned, bull markets typically end in a speculative frenzy. Although some signs have begun to emerge (e.g., the activity surrounding Bitcoin), we are not convinced we are at true bubble stage.
The case for caution.
Based on historical averages, both equity and bond markets are at a minimum fully priced. We are in an eight-year bull market that has seen a cumulative 295% return for the S&P 500*, making this one of the largest and longest bull markets in history. The current economic expansion is already twice the length of the average expansion. Finally, it has been an above-average length of time since even the last market correction.
Some might argue that the stars are just aligning: the economy is gaining speed and lower corporate tax rates are soon to further ignite this. However, we would point to two old sayings: “buy on rumor and sell the news” and “buy stocks when the news is at its worst, not best.” The stock market is a forward-looking indicator. Has the past rise been in expectation of the current environment or have we just begun?
In summary, we continue to believe the potential reward at current levels is reduced while the risk has been increased. This time last year, we built a similar case, although we gave the edge to the positives. As we enter 2018, the pendulum has tilted to a more neutral stance. Returns can be produced, but the risks continue to rise.
Predicting markets accurately is a gamble. No matter what happens, we at NNP will be here to help navigate the waters. Happy New Year!
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