Barron’s has published a very curious article. The piece takes a look at the market and spends a great deal of time showing how the current stock market is both technically and fundamentally sound. The economy is good, market momentum is strong, the rally has good breadth—the whole nine yards. Yet, its overall tone is that investors need to be worried, and prepare themselves for the inevitable downturn. One way to prepare would be to cut out the weakest stocks in your portfolio (likely all with gains, but less than others) as these are likely to fall harder than the best performing stocks. Additionally, consider cashing in some chips, and also, importantly, defining clearly when you will pull out, whether it is when a trend line is broken or at a 10% loss etc.
FINSUM: This market is very rich, but also incredibly hard to time (as always). However, there could still be a lot of gains before a correction arrives.
PIMCO says there is one really big thing to fear in markets above all else—the lack of fear. The current “melt up” is symptomatic of extreme investor confidence, and that is cause for grave concern, says PIMCO, one of the world’s largest money managers. According to PIMCO, “The fact that the fear is gone is the main reason why we should be worried”, continuing “That means most investors are now pretty fully invested and that means they will want to get out if the markets start to correct -- exacerbating the downdraft”.
FINSUM: We think PIMCO has a great point. The market’s start to this year is pretty insane—it is on track to triple in value in 2018. Is this the final run before a big downturn?
The market will inevitably be shocked by some big news this year. Trying to forecast such news always seems like a futile exercise, but Barron’s has gone out on a limb and tried to select what will rock markets in 2018. There a three big calls being made. The first is a US government shutdown on the back of political in-fighting. That might cause a dip, but not a lasting one. The other two could be different. For instance, a looming trade war with China or other major trading partners could cause serious market issues. Additionally, there may be indictments of Trump’s closest family members, including Donald Trump Jr. and Jared Kushner, according to Barron’s.
FINSUM: Indictments of Trump’s family would rock Washington and the national psyche to its core. But it is hard to say that it would have a lasting effect on markets other than to create political uncertainty.
Okay we have a major call to make today, and it could go well, or it could get ugly for us. Our contention is that despite fears of jumping inflation and growth, we believe rates and yields are going to rise only slowly. New Fed commentary shows that the central bank does not expect the new tax policy to significantly affect growth, which makes us feel they will lean towards dovishness. Additionally, with inflation remaining subdued, we think they won’t be under a great deal of pressure to hike. Finally, on the yields front, we expect that retiree demand for fixed income will keep a lid on yields. As proof, just look at how stock funds have seen three years of outflows, while bond funds have risen for over a year straight.
Investors look out, the US yield curve is flattening in a major way. The gap between two- and ten-year Treasuries is now just 50 basis points, close to the smallest spread in a decade. A flattening yield curve can lead to an inverted one, which in turn often signals a forthcoming recession. The flattening has been relentless this year, with the spread falling from almost 130 bp in the first quarter to just 50 now.
FINSUM: Everyone is expecting inflation to jump and the Fed to come out very hawkish next year under Powell. This would have a disproportionately strong effect on short-term yields (which the Fed has more control over). This helps explain the flattening that has occurred recently.
Going by almost all signs, 2018 looks like it should be another great year. The real estate market looks strong, growth is good, there is a new tax cut on the way, and earnings are solid. However, the Wall Street Journal says there are three things that may go wrong. The first is significant monetary tightening, which was supposed to happen this year but didn’t. This would change the picture in bond markets and give power back to lenders while likely sending yields sharply higher. Second, a stronger Dollar could cause a lot of trouble in emerging markets, which could then seep back into developed markets. Finally, China is a big risk. The last two big market falls were both caused by China, and the country still looks on the edge. China has too much debt and is trying to transition its economy, but that is a dance on a knife edge.
FINSUM: There have not been too many gloomy articles recently, but the Wall Street Journal has just put out a real dark one to usher in the holidays! Good to always stay mindful of what might go wrong.