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Financial Industry Insights from Advisors Asset Management
On January 17, 2018
AAM Viewpoints – Let’s Play Two
It seems as though we have been in the “seventh or eighth inning” of the current bull market cycle for years now; long enough to recognize the incredible stretch of positive returns, but leaving a little room for continued expansion. After a few more months or years the popular baseball analogy has transformed into something along the lines of the “eighth or ninth inning of what could be an extra-inning game.” On the heels of an impressive, broad-based rally in 2017 and after a hot start to 2018, perhaps we need to take it one step further by channeling the Hall of Fame infielder for the Chicago Cubs Ernie Banks and say, “Let’s play two.”
The idea of “playing two games” is actually quite timely given this stage of the bull market. January marks the 106th month of the current run (which began in March 2009). According to J.P. Morgan Asset Management research, the average bull market, in terms of duration, is 54 months. If the S&P 500 can make it two more months without a 20% correction the current rally will be exactly twice as long as the average bull market. Furthermore, if the market can hold onto its gains through August it will eclipse the bull market of the 1990s as the longest on record.
Source: J.P. Morgan Asset Management, as of 12/31/2017
To be sure, I will join the chorus of analysts warning of an overdue correction. The S&P 500 Index has not had a 3% pullback since November 2016 (U.S. election), a 5% pullback since June 2016 (Brexit vote), or a 10% correction since late December 2015 – February 2016. On the sector/industry levels we have seen healthy rotation throughout the cycle, but by almost any measure we are due for a broad-based consolidation. It goes to show that 2017 was impressive not only for the positive returns but also because of the minimal volatility. The average level for the Chicago Board Options Exchange SPX Volatility Index (the “VIX”) in 2017 was 11.09, significantly lower than recent years and historical averages. In fact, it marks the first time ever the S&P 500 posted a positive total return all 12 months of the year.
Source: AAM
Looking ahead our mosaic leads us to believe equity levels will be higher over the next twelve months as the global economy is beginning to gain momentum. The macro and micro economic data have been coming in strong and the positive trend appears to confirm a robust environment. For example, we have seen back-to-back quarters of +3% GDP growth (quarter over quarter). To smooth out the data we look at year-over-year GDP growth as well, where the last six quarters have shown steady progress:
Source:AAM
On the micro side, fourth quarter earnings season is just getting underway with analysts calling for 10.5% earnings per share (EPS) growth for the S&P 500 with all 11 sectors expected to report growth. The earnings trend is showing steady progress as well:
Source: AAM, FactSet data
We expect monetary policy to remain relatively accommodative with the Fed continuing a measured approach of slow and steady rate increases and fiscal policy, namely the tax reform legislation, being a major tailwind. Perhaps one area of concern from a fundamental standpoint would be high or stretched valuations. The current forward P/E (price to earnings) ratio of the S&P 500 is 18.4 compared to the 10-year average 14.2, although double-digit earnings growth can go a long way to mitigate this concern. P/E valuation-based indicators are often used as a sentiment indicator, with high valuations indicating high optimism and low valuations indicating pessimism. We believe there is sufficient reason for the market to command an above average multiple and expect equity prices to continue to grind higher over the next 12 months as valuations aren’t unreasonable given the optimism which is based on an economic backdrop that is gaining momentum.
What inning of the current cycle are we in currently? We believe we will soon double the average length of a bull market, with the longest run on record within reach; so as “Mr. Cub” would put it, “Let’s play two.”
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.
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