Monthly Outlook: December 2017

November ended on a high note with the Dow Jones Industrial Average spiking to a new high, piercing the 24,000 level.  Party hats all around!  It was 50 years ago that The 5th Dimension released “Up, Up and Away in My Beautiful Balloon.”  Maybe it should be re-released as this year’s market theme song.  Based on the amount of calls from clients, you’re all well aware of the exuberance and good returns!  But after the first 30 seconds of the call, comes the skeptical question, “Can it last?”  We’ll discuss this juxtaposition, below, but I’ll tell you now that you’d be justified to feel both delighted and nervous at the same time.

Before we look forward, let’s review November.  U.S. stocks (S&P500) did well in November, gaining 3.0%.  This is the 11th straight monthly gain for U.S. stocks, which is very rare.  Much of the strength last month came from the Financials sector which will fare well under proposed tax changes and deregulation.  The normally strong Technology sector took a pause, however.  International stocks also contributed to returns with a 0.6% monthly gain.  Bonds traded in a narrow 0.6% band all month, ending just 0.1% down.  All in all it was another solid month with our iFolios 75 benchmark gaining +1.5% for November.

The Beat Goes On

On the positive side, the economy continues to hum along with corporate earnings up 15%+ over the past 12 months, unemployment is at an 8-year low at 4.1%, and Federal Reserve policy is still stimulative (albeit tightening).  On top of that, markets, at least, seem to like the idea of tax reform that is likely to pass this year in some form.  On top of strong fundamentals, the technicals (charts) look strong, too.  All major stock indices remain in uptrends, defined as above their 200-day moving average.  All 10 sectors (Healthcare, Technology, Finance, etc) are also uptrending.  Bonds are uptrending.  Gold is uptrending.  Everything is working!  That’s obviously very bullish.  We really don’t need to be too concerned until we see at least a few markets “tip” over to a downtrend.  At the very least, that would likely take at least several months to unfold.  Fundamentals support the exuberance.

Valuations on the Other Hand

So the economy and markets are strong, that’s true.  But it’s equally true that the price we’re paying for assets has never been higher.  For years, we’ve tracked the same four valuation metrics: TMC/GDP, P/E10, Margin Debt, and ValueLine MAP.  We know from reader feedback that no one wants to know the details of these nerdy calculations, just the summary.  It’s very clear from our valuation metrics that the U.S. stock market is trading at peak levels, about two standard deviations above normal.  The market is as overvalued today as it was at all previous peaks including 2007, 2000, and even 1929.  It would be easy to argue that the markets ought to correct, and that they could correct by as much as 40% or more to get back to “normal” levels.  What we can’t know is whether they actually will correct, when it would occur, and by how much.  But just knowing the potential is concerning.  Clearly, valuations support the nervousness.

iFolios is the Answer

How should one invest to capture the continued gains, but be mindful of the risks and potential downturns?  Now is not the time to “buy & hold” a risky allocation.  Neither is it time to “cut & run” and move to cash.  Our iFolios strategy combines a thoughtful and globally diversified allocation of liquid index funds (ETFs) with trend following.  Each holding has a pre-determined allocation range.  For example, we might invest between 5% to 13% in U.S. Large Growth stocks, depending on the trend.  Today,  it’s trending higher so we’re 13% invested.  When it turns to a downtrend, and not until, we’ll trim back to 5% for protection.  We do this for every ETF in the portfolio and we look at every holding every day so you can be assured that we’ll keep you well positioned in any market scenario.

Happy holidays to all and thank you for your trust.  As we wind down the year, we hope you enjoy time with friends and family and can reflect on all that is good.