Where to Watch in 2018

Transcription

1 1/9/13 7/9/13 1/9/14 7/9/14 1/9/15 7/9/15 1/9/16 7/9/16 1/9/17 7/9/17 1/9/18 1/9/13 7/9/13 1/9/14 7/9/14 1/9/15 7/9/15 1/9/16 7/9/16 1/9/17 7/9/17 1/9/18 Billings: (406) Conrad: (406) Helena: (406) Missoula: (406) ꟾ January 2018 ꟾ Where to Watch in 2018 With the S&P 500 gaining over 21% in 2017, should we be watching for a reversal in 2018? Or, will momentum continue to carry us higher... the an object in motion will stay in motion theory? It turns out that, even after a strong year, there s about a 2/3rds probability the market will go up the next year. Those might sound like good odds, but they are roughly inline with what the market does in any year. Whether stocks were up, down, or sideways in the prior year, there s roughly a 67% probability they ll gain the next year. More telling about the coming year is the underlying technical and fundamental evidence. Today, there are areas to be concerned about we highlight the recent weakening in Consumer Confidence in this issue but most economic evidence continues to be strong. Yet, with a bull market nearly nine years old and valuations that are well above average, we are taking a cautious approach in the stocks and bonds we are holding... Eric Vermulm, CFA Chief Investment Officer evermulm@stockmanbank.com 2,600 2,200 S&P 500 Index Trailing 5 Years Current Market Statistics 3.3% 2.8% 2.3% 10 Year U.S. Treasury Trailing 5 Years 1,800 1,400 Continued uptrend 1.8% 1.3% Market Update ꟾ Page ꟾ January 2018

2 Feb-67 Feb-70 Feb-73 Feb-76 Feb-79 Feb-82 Feb-85 Feb-88 Feb-91 Feb-94 Feb-97 Feb-00 Feb-03 Feb-06 Feb-09 Feb-12 Feb-15 Feb-18 Consumer Confidence... Not Quite So Confident Consumer Confidence is one of the best leading indicators. Before every recession of last 50 years, confidence has dropped. In December, it was weaker than expected. Is this reversal a warning flag or just a temporary bump in the road? Through last fall, Consumer Confidence was hitting new highs for this economic cycle. We were seeing some of the strongest readings since the late 1960s and late 1990s, both themselves at the end of long economic expansions. 160 Conference Board Consumer Confidence February December Recession Consumer Confidence This has us on alert from these heightened levels any sustained reversal will be a significant warning flag that the average investor is becoming more cautious. The good news is that this was just a one-month downturn, hardly a negative trend. Also, in past cycles, the peak in Consumer Confidence has come (on average) 12 months before the next recession and about 8 months before the peak in the stock market, so there should be some lead time. While this recent downturn is not an outright warning flag yet, we will be closely watching Consumer Confidence in the coming months. Market Update ꟾ Page 2 ꟾ January 2018

3 Feb-67 Feb-70 Feb-73 Feb-76 Feb-79 Feb-82 Feb-85 Feb-88 Feb-91 Feb-94 Feb-97 Feb-00 Feb-03 Feb-06 Feb-09 Feb-12 Feb-15 Feb-18 Yet... Economic Data Continues to Impress The Institute of Supply Management publishes a monthly survey of purchasing managers from across the country. Each month, they poll 300 people charged with purchasing new supplies and managing inventory for large corporations. In the December sample, participants expected to place more New Orders than at anytime since In the past, New Orders will start to slope off well in advance of a recession, showing a weakening trend in the economy. That is certainly not the case today, with the index continuing to reach the highest levels in nearly 14 years. 80 ISM Manufacturing: New Orders February December Recession ISM Manufacturing New Orders While the New Orders component is just one economic indicator and shouldn t be looked at in isolation, a lot of other economic gauges are continuing to show strong results. Jobs and payroll data continue to strengthen with healthy employment gains (although at a slowing pace which is something to watch), stock earnings are expected to continue climbing, and inflation isn t aggressively accelerating. At this point, most economic data remains a tailwind for the market. Market Update ꟾ Page 3 ꟾ January 2018

4 Next 12 Month S&P 500 Return Valuation... The Market s Barometer One aspect of the market that we do not consider a warning flag of an impending market turn, but that still concerns us, is valuation. The most common valuation measure is the price to earnings ratio, known as the P/E. The current value of the S&P 500 is divided by the earnings, of all 500 companies, in order to give us an indication of how much we re paying for the income of the market. Historically, the market trades anywhere from about 8 times earnings at the cheaper end, all the way up to 40 times earnings during the technology bubble. When we look at valuation and compare it to how the market performs over the next twelve months, there is very little correlation. The chart below plots the S&P 500 P/E ratio along the horizontal axis, and shows the market return for the next year on the vertical axis. Each dot shows one twelve month period from % Current P/E 40% 20% 0% -20% -40% -60% Trailing 12 Month S&P 500 Price/Earnings Data Source: Robert Shiller Online Data Set There is almost no trend between valuation and what the market does over the next 12 months the dots are scattered haphazardly. At the current valuation of 23.8 times earnings, we could expect a return anywhere from +35% to -44%. That s a wide range and not much help to us in predicting the market s future path. What would you like to learn about in the next edition of Market Update? Please us your feedback and questions to: evermulm@stockmanbank.com Market Update ꟾ Page 4 ꟾ January 2018

5 Next 10 Years S&P 500 Return Valuation... The Market s Barometer (continued) While valuation isn t much help in predicting the next twelve months return, it is surprisingly relevant when thinking about long-term gains. In the chart below, we show the same chart as on the previous page, but instead of showing the market s return over one year, we show the return for the next 10 years based off of P/E. 400% Current P/E 300% 200% 100% 0% -100% -200% Trailing 12 Month S&P 500 Price/Earnings Data Source: Robert Shiller Online Data Set This graph shows that when you pay a higher valuation, you get a lower return over the next 10 years. If we look at the trend line (the dotted-line on the graph), at the current valuation of 23.8 times, we would expect the market to return 4.8% per year for the next decade. If the market s value was a much cheaper 14 times earnings, we would expect a nearly 9% annual return. While we would be very hesitant to believe the above return expectations there s a lot of dispersion and variables in the data we can be comfortable that when valuations rise, long-term returns go down. The takeaway we draw from this data: you cannot time the market based on valuation, but you can grow more conservative as values rise. Recent issues of Market Update can be found online at the Stockman Wealth Management page of To be included on the distribution list (six issues per year, plus special updates as necessary), please contact us at: evermulm@stockmanbank.com - thank you! Market Update ꟾ Page 5 ꟾ January 2018

6 The Bottom Line There is little evidence that this bull market is at its conclusion. Economic data, like ISM New Orders and Initial Jobless Claims, continues to be healthy. Technical indicators such as the Advance/Decline line are not diverging. And while Consumer Confidence was down in December, most sentiment indicators remain at elevated levels. Still, late stage bull markets can be one of the most difficult for investors. Euphoria in some asset classes (*cough* crypto currencies *cough*) causes many to experience fear of missing out. This happened in the late 1990s (myself included ask me about my battle scars sometime) and in the latter stages of nearly every bull market. That is why we need to take a disciplined and objective approach: watching for warning flags, looking at the risks posed by rising valuations, and focusing on our long-term goals. This approach will keep our portfolios well positioned, not just for the next 12 months, but for the next 10 years. In the battle of Pelusium, which occurred in 525 BC, the Persian Empire attacked and defeated the Egyptian army. According to legend, the Persian soldiers carried cats (a sacred animal to the Egyptians) in front of them into the battle. The Egyptians did not dare to shoot their arrows for fear of wounding the cats, so Pelusium was stormed successfully and Egypt was conquered. Source: Wikipedia The views expressed are those of the author at the time of writing and are subject to change. This material has been distributed for educational/informational purposes only, and should not be considered as investment advice or a recommendation for any particular security, strategy, or investment product. The material is based upon information we consider reliable, but its accuracy and completeness cannot be guaranteed. Past performance is not a guarantee of future returns. As with any investment vehicle, there is a potential for profit as well as the possibility of loss. 402 North Broadway PO Box 2507, Billings, MT (406) North Sanders Street PO Box 7329, Helena, MT (406) South Main Street PO Box 727, Conrad, MT (406) West Broadway PO Box 7789, Missoula, MT (406) Stockman Wealth Management is an SEC registered investment advisor (RIA). We specialize in constructing high quality portfolios based on each individual client s risk tolerance and goals. Through detailed analysis, an objective outlook, and unmatched customer service, we work to be your valued investment partner. Please feel free to contact any one of our offices to learn more about Stockman Wealth Management. Not FDIC Insured ꟾ No Bank Guarantee ꟾ May Lose Value Market Update ꟾ Page 6 ꟾ January 2018