For stock investors, 2017 was a remarkable year. The total advancement of 21.83% by S&P 500 was noteworthy but far from unprecedented. The steadiness of this advancement and the compression of volatility set 2017 apart. In fact, S&P 500 index was up every single month of the calendar year on a total return basis. This feat was echoed internationally. Global equities as represented by the MSCI All-Country index also ascended without a single month of decline. Before 2017, neither of these has ever happened.
That it is remarkable is perhaps the only thing which investors can agree upon. Some would argue the lack of volatility is proof of investor euphoria. With euphoria, could a full-blown bear market be far away? Others would counter that the 2017 bull market was rationally driven by strong corporate profit, expectation for lower tax rate and easy financial conditions driven by timid central bankers. Even on the sentiment front, investors have consistently underweighted stocks throughout this long bull market. The most recent survey of institutional investors conducted by the Boston Consulting Group showed that 46% of money managers were pessimistic heading into 2018, an increase from 32% shown in 2017. This study shows that investors are increasingly gloomy, not ecstatic.
“An object in motion stays in motion.” states Newton’s first law of physics. The forces that maintain the present motion of stocks are strong corporate earnings and easy monetary policies. For 2017, S&P 500 earnings are expected to grow 10.9% against 2016 levels. For 2018, this year over year metric is expected to reach 11.8%, both according to Factset Research. Even though earnings expectation tends to shrink as calendar marches forward. Given the synchronized growth of global economies, the expectation for double digit growth is certainly achievable.
In the United States, the Federal has embarked on a course of hiking interest rate and shrinking balance sheet. Due to its deliberate pace, the tightening effect of Fed’s action is more than offset by stronger economic growth. The combination results in still looser financial condition. Globally, monetary authorities in Europe and Japan are still maintaining a course of policies designed to resuscitate depression like economic conditions; hence both regions are showing accelerating rates of growth. In fact, all OECD countries are now showing economic growth, a condition rarely observed in history. According to JP Morgan projection, the combined balance sheet of US, Japanese and European central bankers will not start to shrink until 2019.
Those forces that buoy the market are projected to remain intact in 2018. As a baseline projection, the objective observer must also maintain that 2018 will be another year of gain for stocks. Yet as fund managers, one must be constantly reminded that future is unforecastable for it is contingent, not deterministic. It is not the forecast, but the change of such forecast given the unfolding stream of information that determines the value of an investment professional. Many have used baseball’s late innings to characterize the current market condition. That I wholly agree. Yet just like baseball, the bull market also has no pre-timed ending. The present game may last yet another year.
Dong Hao Zhang
President & Chief Investment Officer