We covered some of the key events that happened in 2017. Now let’s take a look into what that means for 2018.
The Bull Market
Currently, we’re enjoying the second-longest bull market of the last 100 years. We’re not sure how long this will last, and that makes some folks understandably nervous. But one important thing to remember is this: bull markets don’t die simply from old age.
Valuations are above historical averages, but this doesn’t mean they’re particularly concerning. Why? Because of tax cuts and interest rates. With tax cuts boosting earnings for most companies (though not yet fully reflected in analyst projections), valuations are not especially frightening.
Also of concern to some is a flattish yield curve, which historically have been precursors for recessions and declining stock prices (i.e. flat or inverted yield curves). Longer-term rates remain stubbornly low. But today, low corporate bond yields are providing cheap financing for most publicly traded companies.
We don’t see signs of economic slowdown or anything that may impact the availability of credit/liquidity, which typically are the enders of bull markets.
Stock prices are a function of supply and demand, and supply is shrinking, with the number of public companies shrinking by more than half in the last 20 years, and total shares outstanding on the S&P 500 falling about 22 billion since 2011, according to Yardeni Research.
So as the money pouring into stock funds are sourced from things like 401k and pension fund contributions, or bonuses getting invested, it is spread among fewer stocks and fewer shares, making those shares more valuable. While it’s impossible to know this trend’s full impact or how long stocks will benefit, a reduced supply could be a powerful bullish force.
U.S. stocks have dominated their international counterparts in this bull market, which resulted in higher valuations. The forward PE of the MSCI US Index is 19, while the forward-looking PE of the rest of the world is 16, according to MSCI, and on an even playing field, that makes international stocks more attractive looking ahead. As always, we strongly believe a strategic allocation to each, and a disciplined approach to rebalancing, gives the best chance for long-term success.
Sector Bets Are Getting Bigger (Again)
Most bull markets are headlined by a specific sector. This year, Technology is again rallying and gobbling up share of the market in the process, now representing 24% of the S&P 500. If you are an index investor, you should probably take notice, since this may be a bigger bet than what you realize or want especially if you also own individual stock positions in favorites like Apple, Google, Microsoft, Amazon or Netflix. Chinese technology stocks have experienced a rapid rise, so a similar issue exists in many international stock index funds.
We are not bearish on Technology stocks, or growth stocks in general. The recent rally and valuations are nowhere as extreme as we saw in the late 1990s and it is entirely likely to continue for another year or more. But we do think it is increasingly important that investors are aware of their exposures.
To learn more about what happened in 2017 and our outlook for the new year and beyond, read our free Q4 Report.
Craig Birk, CFP®
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