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Peroni Report: 2018 Outlook


DJIA: 26,115

1. Still a “time in” not a “timing” market. Some forecasts among portfolio managers and market prognosticators are calling for significant shifts in market leadership in 2018. Our position is that those sectors that led the market in 2017 (and, for that matter, from the start of this cycle in 2002) will continue to lead in 2018. The market has consistently policed price and sentiment excesses through rotational consolidations and short-lived general market pullbacks. This has reinforced the technical footing for many sectors and it is unlikely that there will be a sea change in market leadership this year. I believe one of the more significant risks in 2018 may be selling best-in-class stocks too soon.

2. Investor confidence improved in 2017 over the previous year but this renewed optimism did not bubble into euphoria. Buying remained orderly and propagated over a broad swath of industry categories and investment themes. The stock market seemed to “sense” more money flowing into stocks from the sidelines and the window shut for those awaiting a 10% correction. Not even a 5% pullback developed last year although some “momentum” sectors underwent significant and constructive consolidations. The absence of concentrated, micro-thematic buying and the presence of effective rotation suggests the market is far from an ultimate top.

3. Attractive risk/reward ratio for stocks preserved through routine rotational consolidations among leading industry sectors. It is remarkable that despite the big gains realized in 2017, stocks remain in proximity to buy levels as the New Year begins. This is the result of constructive backing and filling exercises in many stocks which has occurred without disruption to the overall market. Support is being established and reinforced at incrementally higher levels, making many stocks virtually as attractive today as they were more than a year ago.

4. Inflation could become a significant theme for investing in 2018.  The bullish trends of most inflation-sensitive sectors including industrials, materials, metals and oils may indicate that the efforts of central banks globally to re-inflate their economies following the 2007-2008 financial debacle is proving successful. Inflation is not necessarily a foe of a bull market until it becomes unruly, causing the Federal Reserve Board to take aggressive, hawkish action. I believe this is an unlikely scenario for 2018.

5. Raising end-of-cycle DJIA target from 27,500 to 32,000. This represents a 16% upward revision and is based on my price projections for blue chip component issues. I believe 2018 will find the broader market indices performing more in line with the DJIA. The S&P 500 (SPX) and Russell 3000 (RAY) each lagged about 500bps (basis points) in 2017. This new target represents a conservative estimate and illustrates my risk/reward ratio projections based on longer-term support near 23,750.

6. Broad and diverse sector leadership continues. As 2018 begins, buying remains widely propagated among many themes with few indications of unruly buying or overextended chart patterns. Positive net money flow trends support the bullish price actions in numerous individual stocks. Given such a long bull market run, it is extraordinary that this characteristic is still firmly in place. It is one of the most important qualities of this cycle. The depth of attractive individual stock representing the market’s core leadership categories remains excellent and implies that there is little thematic speculation in the market.

7. Oil could break into the $70s during 2018. West Texas Intermediate (WTI) produced a substantial base in 2017 and the improving relative strength toward year end suggests that a breakaway advance could unfold in 2018 that propels oil to $72, or higher. Energy stocks may be reflecting increasing global demand and the onset of an inflationary stage. On a longer-term basis, I anticipate WTI, will re-test resistance at the $90 level.

8. Some of the most exciting days may still await this bull market cycle.  This bull market run has delivered tremendous gains since its inception and with few exceptions the advance has been orderly and has proceeded without great fanfare or media notoriety. I believe the current cycle is the third installment in a bull market trilogy. The first installment occurred between 1982 and 1987. Nearly 40% of the gains in that cycle were realized in its last nine months, with the bull market ending with climactic buying. Similarly, the last cycle between 1988 and 2000 ended euphorically with the infamous technology bubble. Arguably, it was the last three years of that 12-year cycle that were the most colossal. Today, with the market at all-time highs and with few indications of capitulation, it seems to me this cycle has yet to enter a highly optimistic point and is still far from a euphoric stage that could catapult stocks to substantially higher levels within a shortened timeline. The proliferation of cup-and-handle formations strongly suggests that this cycle will end much like the previous two since these price patterns combined with longer-term net money flow trends provide a powerful elixir for explosive upside potential. We think a 500-point-plus rally day for the DJIA is not a pipe dream and may not be that far into the future.

9. Commentary on eight in-favor sectors/themes:

Aerospace/Defense. This will likely remain a forefront theme in 2018 as the Trump Administration makes military readiness a principal priority. Most stocks in this sector are still in reasonable proximity to buy points. It is also noteworthy that this category has a good balance between large and medium/small capitalization component stocks.

Agriculture. With materials exhibiting improving relative strength, agriculture could also get more attention as the wealth effect becomes a talking point. Strides in global wealth could mean higher meat consumption and greater demand on grains and related products.

Consumer Discretionary. The consumer is clearly at the epicenter of economic growth. Name-brand companies in this group have performed well through most of this cycle and 2018 could be a banner year for this sector. Investors seemed to favor the perceived safety of name-recognizable companies last year and this trend could continue well into 2018. Consumer confidence is also likely to stay at higher levels as business activity accelerates.

Energy. I first presented the acronym T.H.E.M. (Technology, Health Care, Energy, Manufacturing/Materials) in 2003 to describe the core leadership in the market. Today these groups are still alive and well, and energy-related stocks have now broken out from base formations. My prediction for WTI stated previously supports our positive technical outlook for fossil fuels in 2018.

Financials. I anticipate financials will exhibit improving relative strength in 2018, although I expect they will be more in-line performers relative to the market. Brokerage, Health Care insurer, and property/casualty stocks remain attractive.

Health Care. One of the most appealing features of this leading group is that most of its subcategories from health care equipment and services to big pharmaceuticals remain technically attractive. And, despite strong gains in 2017, we believe biotechnology should remain a top performer based on well-established technical credentials.

Infrastructure. This broad theme includes heavy equipment, building materials, engineering and diversified industrials. These categories have been part of the market’s core leadership from the start of this cycle from 2002 and should continue to lead in 2018.

Technology. This is another sector that sports many attractive sub-categories that touch virtually all areas of the economy from smart phones to homeland security and from autos to shippers. Software and semiconductors are exhibiting strong relative strength. Data and storage stocks are also attractive.

 

CRN: 2018-0112-6335 R

Opinions in this piece are those of Peroni Portfolio Advisors and are not necessarily that of AAM.

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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Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.

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