"Data over the past 120 years shows that whatever happens in one year has very little impact on returns or probabilities the following year. If stocks gain over 20% this year, their return next year is not much different than if the market had fallen this year (right column). Moreover, the odds of stocks rising next year is the same regardless (second chart; both from Mark Hulbert)."
December FMS takeaways
- Icarus loves Cash: Dec FMS shows investors raising cash to 4.7% from 4.4% despite surging credit & stock markets, paving way we think for more risk asset upside in Q1. BofAML Bull & Bear indicator @ 6.2 is not excessively bullish, consistent with further Icarus trade upside. When asked when equity markets will peak, 25% of investors sayQ1’2018, 30% say Q2, 28% say H2.
- Golditrumps: consensus still smitten by Goldilocks...54% expect “high growth, low inflation” in 2018. Almost 2/3 investors believe US tax reform will induce higher stocks& rates, but fiscal stimulus has coincided with lower, not higher profit expectations, and that will need to change given EPS leads relative performance of cyclicals by 3 month(Exhibit 10).
- Pro-cyclical Consensus: Investors are long macro “boom”, short “bust”; long stocks,EU/Japan/EM stocks, financials (2nd largest ever), materials (highest since 2/2012) vs short government bonds, US stocks, healthcare & utilities. Pro-cyclical consensus entrenched by US tax reform across asset classes, bar, intriguingly, leading tech sector where allocations dropped to lowest since June 2014 (Exhibit 4).
- FMS Crowded Trades: ...#1 long Bitcoin (32%), #2 long FAANG+BAT (29%), #3 short volatility (14%), while expectations for a “flatter yield curve” surged (highest in 18months), all trades vulnerable to higher inflation & aggressive ECB/BoJ Quantitative Tightening in 2018.
- Contrarian Recession Trades: ...a recessionary bust even more contrarian than inflationary boom, lower rates more contrarian than higher rates, making short equities long bonds, short banks-long utilities, short EAFE-long US stocks the most contrarian trades of all heading into the new year.
In conclusion, we remain firmly in the secular bull market camp. Yet, we also know from historical norms that the average intra-year drawdown is 14% in the S&P. 2017 was clearly an anomaly with regards to volatility as the biggest drawdown was a measly 2.9% and the last 5% drawdown occurred almost two years ago. We expect a bigger drawdown at some point in 2018 coincided with a rise in volatility. Regardless, we don't think it will derail the bull market and should be used as a buying opportunity as US equities remain underweight. One of the biggest reasons we think predictions are so silly is the global markets are so dynamic as information changes rapidly. At any given moment a new catalyst can reshape our thesis, however as we stand today the investing landscape looks promising into 2018 with the potential for an upside kicker in US markets based on tax reform.
We want to wish everyone a happy and safe holidays and look forward to what 2018 holds!