US Equities again surged higher during the trading week ending January 26 with the S&P up another +2.2% and now a staggering +7.2% higher YTD. Thats getting close to what many strategists expected might be the full-year result in just 1 month; with just 3 trading days remaining January looks to be one of the best new year starts ever (presently ranking 5th). Historically January strength in the magnitude of that witnessed bodes well for the full-year. With that said, there are some big divergences opening in recent performance. Notably, mega-cap tech (growth) is again fueling gains at the aggregate index level while more cyclical and value-oriented names are more muted. Smaller-size companies with generally lesser foreign exposure are not fully participating as many cite a dramatic weakening of the US$ so far in 2018. Too, bonds are the stark contrast to a stock market where it seems everything is up. Yields have risen materially in both the US and abroad these first weeks of 2018, resulting in softening prices and negative total return. The great rotation, hypothesized as imminent in almost every year since the financial crisis but nearly forgotten now, finally seems to be unfolding before our eyes. One favorable aspect of that does appear to be a modest steeping of the yield curve which grew ever flatter (and nearer to inversion) throughout much of 2017.
From an economic perspective, corporate earnings season for 4Q 17 is in full swing. Profits are generally meeting or beating expectations, but the even more significant story is the rate with which top line (revenue) beats are occurring. Higher revenue is generally interpreted as higher economic demand, rather than just a result of creative financial innovation and leverage which can prop earnings even in less robust times. We did learn that the first measure of 4Q GDP failed to achieve the hoped-for 3% rate (after backing out inflation), but nominal numbers are healthy and hard to get upset about. On the political front, the Government shutdown that began a week back and bled into Monday was a non-event with the markets ignoring it; even though it must again be revisited in February. Seems government dysfunction and partisan division is very much alive and well in 2018. We observed it in the few brief moments watching the Grammy Awards last night and expect to see signs of the polar partisanship on full display in Trumps first State of the Union address scheduled for tomorrow evening. International economic metrics continue to be encouraging, even as the potential theme of nationalistic protectionism (trade war) seems to be bubbling and was evident in prominent speeches at the annual World Economic Forum in Davos last week.
With January coming to a close, one thought that strikes us as we write this brief summary today is how important the market trend is to the context in which news is viewed. In many ways, some of the recent geopolitical volatility (be it tensions with Russia, North Korea; or jawboning the US dollar lower relative to major trading partners like Europe and China in trade-war like themes) is surprising to not be translating into more nervous markets. Seems a rising stock market can cure all? But to that end, the biggest risk may be the one that is hardest to evaluate in terms of how it will rear its head: market complacency or underappreciating the risks that do exist. As we have written almost weekly, we anticipate that 2018 will be a positive full-year experience (even from the already appreciated levels as we sit today). But, we do expect that after 399 trading days without even a 5% peak-to-trough pullback, we are overdue for some sort of reminder that there is always risk with investing and that markets cannot go straight up forever without a pause. Perhaps that will manifest itself through an inflation scare (many moving pieces both in US and abroad that seem to all point toward rising US inflation). We encourage clients and investors to fight the urge to abandon or change long-term asset allocation objectives in pursuit of keeping pace with the hottest areas of the market.