While many market pundits are talking about when we will finally see a correction, the market continues to rise without even a minor pullback. In 2017, the market set many records. Here are a few:
*The Dow Jones Industrial Average (DJIA) had less than a 1% intraday move for 95% of trading sessions.
*The DJIA closed at record highs 71 times in 2017.
*The S&P 500 was up every month of 2017 and ended the year up a record 14 consecutive up months.
*The S&P 500 has not had as much as a 3% pullback since November of 2016. This stretch is much longer than the previous record which was set in 1995.
A normal “backing and filling”, profit taking correction will happen. The question is always from what level. We continue to advise that as long as the big picture fundamentals do not change, a correction will actually be healthy longer term. An opportunity, not a reason to panic.
Last quarter we wrote, “we would argue that the risk of a market melt up could be more of an issue.” One of the reasons we thought the market may get ahead of itself was meaningful legislation getting through Congress. Well tax reform is here. Some market analyst believe tax reform could add as much as $12 to $15 to S&P 500 earnings. This would be about an 8% gain all other things being equal. The DJIA was up 10.33% during the 4th quarter and, even on top of that, has risen 4.2% year to date post tax reform. That is the best 10-day start for a year since 2003 when it gained 5.9%.
We believe the market is still adjusting to expectations as to how tax reform will affect the bottom line of corporate America. However, all systems seem to be “go” anyway as S&P 500 profits are expected to have risen 11.2% in the 4th quarter 2017. And, for the first time since 2011, all market sectors should post an increase in both revenues and earnings per share.
The S&P 500 and Nasdaq have only closed down once each so far this year and, there is obviously a tremendous amount of momentum. Generally, when a year ends with the amount of momentum shown at the end of 2017, the market will advance again the following year. So, a “melt up?” We do not think so and, we believe the risk to the rally is small when compared to the economic growth we are experiencing.
Interest rates are rising. The 10-year US Treasury bond is at 2.55%, the highest since March of last year and the 2-year breached 2% for the first time since late 2008. Many would argue that the market cannot continue up as rates rise and that, in fact, there is an inverse relationship. Higher interest rates are a sign of better economic conditions which is positive for earnings growth. Inflation and interest rates are not negative for the market until they reach a level that curtails economic activity. We believe that situation is still far off.
Though the recent velocity of the market does cause us to be cautiously optimistic short term, we remain intermediate to longer term bullish as the underlying fundamentals are not only stable but, improving. Look for mid-quarter updates on our website under the Latest News section. Stay warm this winter!
Royal Fund Management, LLC