John Authers gives his summary of markets in 2017 and his outlook for 2018 in the FT this morning. John argues that long-term interest rates are the key risk to watch in 2018. Sans a rise in long rates, known risks look benign. As for unknown risks, well… there is a reason we have long advised a balanced approach, diversified across asset classes and regions.
Below are some of the highlights from John Authers’ FT column. You can read the full article here (subscription required):
Record Low Volatility in 2017
This can’t carry on, can it? This is the last Long View of 2017, the most serenely positive year for world markets in history. US stocks varied less than in any year on record, bar 1964; the MSCI World index made a gain in each month, for the first time ever, and anyone betting against volatility with inverse Vix index exchange-traded notes could have tripled their money.
At this point, columnists such as me are supposed to make predictions. I did not see the calm sea and prosperous voyage of 2017 coming. As 2017 was literally as good as it gets, it is a very safe bet that 2018 will be harder, but that does not mean that it will be a bad year. Arguably the most important force in markets is momentum; once prices are in motion, they tend to keep going in the same direction for a long time. Something needs to interrupt them.
Valuations are Excessive, but an unreliable predictor of short-term returns. Earnings growth looks poised to continue double digit gains providing a tail wind for stock prices.
So the precise constellation of conditions that made 2017 so good will not continue. But that does not prove that there will no longer be easy gains from the stock market. If earnings do increase, that will help stocks (the consensus prediction for this quarter is 12 per cent growth, according to ThomsonReuters, with double-digit growth rates to continue throughout next year).
Valuations are excessive, particularly in the US. Over 10 years or more, that matters a lot. But over one year, valuation says almost nothing. US stocks could easily get more expensive.
The Most Important Price in the World
The 10-year Treasury yield, arguably the most important number in world finance, which sets the notional “risk-free rate” in global transactions, has trended down steadily ever since Paul Volcker’s Fed stamped out inflationary psychology in the early 1980s. Bond yields have ticked up since the tax cut passed and are very close to breaking above that steady downward trend.
Scepticism about chartism and technical analysis is always justified. But sometimes a trend is so obvious and strong that it is foolish to deny it. If the downward trend in 10-year yields were at last broken, it would be profoundly important.
Most traders today have no idea what it is like for yields to trade upwards. It would open the risk of a financial accident. Sharply higher yields would crimp the economy, put over-extended corporate credit under pressure, and render high stock valuations impossible to justify. It could change everything for asset markets.
This is a real and present danger. If we exclude unmeasurable risks of warfare or natural disaster, it is by far the greatest risk facing asset markets….
Authers’ Investment Advice for 2018:
Where does that leave us? On balance, investors should stay in the stock market, as a big bear market looks unlikely as early as 2018 — but carry more in cash than usual and substitute cash for some bonds. That approach would have done fine last year in absolute terms; but you would have missed out on the best of some very easy returns. For 2018, I suggest running the same risk of missing out a bit again.
Jeremy Jones, CFA
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