The Grateful Dead sang, “…when life looks like easy street, there is danger at your door.” To the fear mongers, investing in 2017 and, for that matter, in each of the eight years that preceded it, has been too, well, easy. Among the most common questions we are receiving is, “When is the correction coming?” For what it’s worth, rounding out the top five is: how high will bitcoin climb (I don’t know); will the tax plan usher in a new era of growth and steepen the U.S. Treasury yield curve (unlikely); is the emerging market rally over (doubtful); and what is wrong with the New York Giants (this deserves its own blog).
The answer to whether a correction is coming has always been an easy one. Yes. Corrections are always coming. As we have been saying for years and, as the well-known Exhibit below depicts, there has been a greater than 5% correction in the S&P 500 Index in every year since the early 1980s but one (1995). That is, until now. Barring any major hiccups in the last few weeks of the year, 2017 will go down as the second year in the past 35 years without a meaningful intra-year decline. Maybe I shouldn’t jinx it?
If that’s not enough, 2017 is also on track to be the only year in the last 90 years in which U.S. stocks posted positive gains in each of the 12 months. The benign market environment wasn’t just a U.S. phenomenon. The monthly returns of the broad global equity index were normally distributed with no tails of extreme up or down performance. That rarely happens. In short, 2017 was exceptionally “normal” (how’s that for an oxymoron?).
Global Growth and Policy Clarity Are Supportive of Risk Assets
So, is there danger at our door? It’s unlikely. In our 2018 Outlook, we attribute the strong market returns and lack of significant drawdowns to the absence of economic and monetary policy uncertainty globally. A large majority of the world’s developed and emerging market countries are growing above their own trend growth rates. And easy monetary policy globally, with inflation falling in emerging markets and still benign in the developed world (the recent Fed rate hike notwithstanding), is supportive of risk assets.
Therefore, we reason that it is highly likely that equities globally will perform well in 2018. Will the environment be more volatile than in 2017? Perhaps. Will there be a market correction? History suggests there’s a good chance there will be. We believe that any correction will represent a buying opportunity in this elongated secular bull market. The cycle will ultimately end with higher U.S. inflation, significantly tighter U.S. monetary policy, and an inverted U.S. Treasury yield curve. But we are not there yet.
Finally, if it makes the naysayers feel better, as the Exhibit above shows, years of normally distributed market returns like 1995 and 2004 were followed by multi-year equity rallies. In actuality, it is the more volatile years like 1999 and 2007 with a great number of large up and down days that are often the harbingers of worse things to come.
For now, to borrow from another Grateful Dead song, we suspect that the market will “just keep truckin’ on.”
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