Returns for the major stock indices for the first quarter of 2018 and the current bond market yields are as follows:
|Dow Jones Industrial Average||-2.49%|
|Fixed Income Yields||1 year||5 year||10 year||30 year|
The equity markets are off to a bumpy start in 2018. After a blistering January, continuing the unprecedented, non-stop (15-month in a row) rise since the presidential election, the market experienced one of the fastest 10% declines (January 26th to February 8th or nine trading days) in history. The markets have not recovered back to the highs of January as we have just logged our first down quarter since the third quarter of 2015. We could write at length about algorithmic trading, tariffs and other noise associated with short-term market declines but won’t because we do not believe them to be relevant to long-term investors and do not want to give merit to this type of short-term dialogue. As long-term investors, we know the markets regularly correct and we understand that the uneasiness associated with market volatility is the price we must pay to be long-term investors. However, we will always continue to seek perspective, humility and assurance.
The primary objective of our quarterly letters is to highlight our most relevant thoughts on our outlook for the current markets. Despite recent market turbulence, we continue to remain positive on the equity markets for 2018 for many reasons. The following indicators we highlighted from one year ago are still in place to continue the bull market:
- The yield curve is not inverted: This is when long-term interest rates yield less than short-term rates. Rates have risen over the last several quarters but the slope is still upward (healthy) and rates are still low by historical standards.
- Stock prices relative to forward earnings ratios are not excessively above norms: Earnings are still rising and no significant earnings warnings have been announced. Forward PE ratios are 17; in line with historical averages.
- There is no euphoric buying/speculative excess in public equity markets: We still see few signs of excessive speculation
- There are no heavy inflows into equity funds: Investment into equity funds (-159 billion in 2017) vs. bond funds (+260 billion in 2017) is nowhere near comparable peaks in the markets though the incredible inflows into bond funds since the Great Recession are a concern for bond valuations.
- There is no significant increase in IPO, merger or acquisition activity: When companies “go public,” merge or acquire other companies in large numbers, this often correlates with the sign of a market top.
- Real interest rates are not rising: Rates have risen over the last year but have not broken any significant trend lines and are certainly low by historical standards.
- Corporate cash on balance sheets is not declining: Corporate cash continues to be near record highs.
Though we remain positive on the overall equity markets, an ongoing conversation we continue to have is the concerning similarities of the stories of the Nifty 50, the Four Horseman and the FAANG trades. What are we talking about? These are the nicknames for the “growth at any price” mindsets that consumed the end of the bull markets in the early 1970s, the late 1990s and perhaps our current bull market. The three clever names above tell the stories of never-ending growth, the “this time is different” or the “you don’t understand” trade where all an investor has to do is buy the stocks associated with these names and never look back. We concede that the stories are always different (but valuation reversion is not) and the current FAANG trade does include great companies that are still fairly valued, but we believe some are drifting into repeated history. A few names where Wall Street has decided that reasonable earnings valuations do not matter are Amazon, Tesla and Netflix. All are exciting companies and stories, all trading at euphoric “earnings” valuations. We highlight earnings valuations because we know stock prices can stay irrational for long periods and certainly do not pretend to know when the market will force them back to normal valuations; but someday earnings will matter. The above discussion reminds us why we take great pride and effort in buying the highest quality investments at reasonable valuations while always diversifying against excessive conviction.
We genuinely appreciate your business and value the trust you have placed with us in the stewardship of your financial assets. As always, we welcome and encourage you to schedule an appointment to review your personal financial situation.
Ryan T. Lynch, CFP® ChFC®
Form ADV Part II of the LYNCH & Associates Uniform Application for Investment Advisor Registration and the LYNCH & Associates Code of Ethics are available to all clients at any time. If you would like to receive a copy, please contact Jennifer Farless at (812) 853-0878 or jfarless@LNAonline.com.
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