Monday, January 01, 2018

Is The Glass Half Full Or Half Empty

The end of Friday trading was certainly interesting as the last thirty minutes of the trading day incurred most of the day's half of a percent loss. A few Twitter posts I read were comments in the vain of "this is the selling I have been anticipating." The market is over due for a pullback.

Although the first day of January is simply another day on the calendar, much is made of the fact it is January and a new year. So what is to be expected from the equity market in 2018?

I will admit that top of mind is the fact the S&P 500 Index has not had a double digit pullback since early 2016, nearly two years ago. The market will experience one of these, probably sooner than later; however, I am reminded of the quote made by Peter Lynch,
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

Investor should remember that strong equity market returns tend to cluster and run together in a multi year fashion as can be seen below.

A part of the reason positive returning years tend to cluster is the fact the market ultimately trades on fundamentals, both economic and business. One strong and important fundamental with this current market cycle is an improving earnings growth picture. After the weak earnings environment in 2015 and early 2016 resulting from the contraction in energy prices and a currency headwind due to a strong dollar, the February 2016 market bottom coincided with a return to strong earnings growth. This past year will likely see S&P 500 earnings growth of a low double digit percentage rate and projected 2018 forward earnings growth of low double digit rate again.

And there is a lot of truth to the fact that stock prices tend to follow earnings and seen in the below chart. If earnings growth is near a low double digit pace in 2018, and tax reform is a tailwind, equity market returns could be strong in 2018.

The bull market of the 1950's and 1980's have similarities to this recent bull market that began in 2013. I compared these bull market periods in a post in late 2016 titled,  Equity Market Beginning To Resemble Bull Market Of The 1950's And 1980's. The market path traveled by these three distinct periods have remarkable similarities. If the current cycle simply rhymes with history, this current bull market may have another five or so years to run. 

And finally, for investors, the period from 2000 to 2013 saw investor returns just tread water. Not until 2013 did the market breakout above the high in 2000 and the high in 2008. Consequently, the market's annualized return since the peak in 2000, i.e., nearly 18 years, is 3.16%. Conversely, the ten year period from 1990 to 2000 saw the market return an annualized 15.9%. The point is, yes, returns have been good since 2013; however, the entire period from 2000 has been very underwhelming. The past 18 year return period does not look like bubble level returns.

At the end of the day, from a return perspective, the market looks half full. A positive earnings backdrop and positive economic backdrop are supportive of higher prices. I get the valuation argument and have discussed this issue in earlier posts. The market is way past due for a correction and we will get one; however, as the Peter Lynch quote above notes, a lot of money has been lost waiting for the pullback.

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