Gains Accelerate Bringing Both New Joy and Concern – Week Ended 12/1/17

The final trading week in November was decisively positive for US equities; in fact on Thursday the Dow achieved its 5th 1,000 point milestone by crossing the round number of 24,000 and was led by financials and transportation companies in what is ordinarily a signal of fundamental economic strength. The Dow actually concluded up +2.9% on the week (with financials up +5.2%!) while the S&P500 managed a weekly gain of +1.5%. It was noteworthy however that the technology sector, which has been the far and away leader throughout 2017, surrendered -2% and causing the Nasdaq to slip -0.6% during the week. In that vein, it would seem as we enter the final month of the year that some of the most swiftly appreciating names and areas of the market are taking a breather while others play catch-up. Fortunately, some of these areas most notably participating in recent days are those that tend to be thought of as more cyclically sensitive. Is this the start of a broader thematic shift, or just an overdue catch-up in participation by areas of the market that would seem to benefit most from the passage of tax reform making its way through Congress (more on that in a moment)?

From an economic perspective, the synchronized global growth theme seems to remain in good health judging from recent data points. To this end, the Citi global surprise index made a new high, and the Baltic Dry shipping index with the price of industrial commodities such as iron ore also made upside breakouts. In the US, stronger data included an upward estimate to 3Q GDP, rising oil rig count, vehicle production, consumer confidence (now approaching a record-high), and a concert of stronger home-related data. This is all while inflation related measures continue to remain a non-problem. In fact, so much of the data recently seems to be coming in favorably, that the narrative surrounding the market performance YTD is beginning to attract some irrational exuberance type labels (a term used to describe the markets by then Fed Chair Alan Greenspan in 1996 when the tech bubble was building). Indeed, there are some signs that some market participants are getting a bit euphoric and chasing or piling into what would seem to be some of the most risky areas. [Bitcoin for instance; without veering too far off-track, the appreciation of cryptocurrencies is making a number of prior bubbles that preceded their historic crashes look benign by comparison and that is to say nothing of the challenges we have with trying to understand the fundamental case behind the trade at any price level. Bubbles like Bitcoin can of course persist longer than reason suggests they should; precisely what makes them so alluring and risky] Interestingly, Greenspan first referenced the famous irrational exuberance term in 1996, a good 3 years before the high-flying technology sector and broader market experienced its day of reckoning.

As we enter the final month of 2017, a review of how far the markets have come is encouraging. Improving economic fundamentals seem to have delivered upon what the market was anticipating or suggesting when it began the current move higher back nearly 23 months ago. Now, what seems to be a rising probability of success with respect to Congress delivering tax reform (particularly at the corporate level), has the potential to add fresh fuel to the tank in terms of helping companies boost earnings margins and further lift confidence. At the same time however, it is the same virtually uninterrupted walk higher that has many investors growing concerned. YTD, the largest peak-to-trough decline is just -3%; that is the 2nd narrowest giveback from January to December in at least 70 years according to market research group Strategas. That alone suggests volatility will go higher from its current levels of tranquility; and volatility is historically inversely correlated to the price direction of equities. But before getting too spooked, it is worth noting that history offers that gains are still probable in the following 12 months; the pace of those gains however slowed and a much wider range of outcomes was possible. Bluntly stated, the probability of some form of corrective price action in 2018 appears high even if the longer-term theme of upward economic momentum remains intact as we think it can. Such an interruption might likely occur because inflation should pop up from its current non-visible state at some point, causing participants to fear a quick shift to a less accommodating monetary policy mix. In the near-term however, the final month of 2017 seems set to push higher.

Posted in Blog Post.