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January Newsletter - 2018 Looks Good, but not All Good

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First the Facts

 

Let’s start with the facts, then move to the bad news and then the good news. Below is a picture of the Dow Jones Industrial Average over the last 10 years. From the high in May of 2008 to the low of March 2009 there was a drop of almost 50%....50%. (13,020 to 6,763) Can you imagine if you had just made your first investment in the Dow in May of ’08 and watched half your investment evaporate in the next 10 months? But wait, if you had kept it, to now it would have doubled (13,020 to 26,140 as at Jan. 22). So wait, what? A double in 10 years? That is exactly the rule of 72. If something doubles over X years, what is the annual % gain? Well in this case from May of ’08 until now its roughly 7.2%. This is consistent with the long-range expectation of the equity markets in general.

 

Dow Jones Industrial Average 10 Year History

Source: Bloomberg

 

Now the Bad News

 

Or put in a softer tone, a cautionary note. We have just witnessed the longest period ever without a 3% or greater decline. The last time the stock market pulled back by 5% was June of 2016.  

 

Bull markets tend to last longer than bear markets and as a result have far greater absolute upside. Since 1926, the average bull market has been 9 years long and added 480% to the S&P 500. The average bear market lasted only 1.4 years and resulted in a loss of 41%. Our current bull market is now verging on 9 years old and so far this year showing little signs of slowing down. Naturally, citing the above facts, the prudent investor would expect a meaningful correction sometime in 2018. (see a chart of the history of bull and bear markets here).

 

One well respected market strategist, Bryon Wein, Vice Chair of The Blackstone Group suggests that the markets are now at a point of near euphoria which will result in a 10% pullback during 2018. He does however believe that the markets will end the year on a positive note. Of course, no one has a crystal ball and no one knows the timing.

 

Keep in mind that corrections, while painful to experience are part of a healthy market.

 

And the Good News

 

We continue to be in a global growth environment with inflation and interest rates in check. It is hard if not impossible to find and equity market or broad economy in stress. Unemployment is extremely low here in North America and as much as we hate to admit it, Trumps tax cuts are predicted to add 0.5% to the US GDP this year pushing it to 2.7%.

 

To substantiate all of this let’s have a look at a leading indicator the economic health of a countries economic health, The Purchasing Managers' Index (PMI). In a growth environment, the purchasing decision makers are buying inventory to deliver on factory orders. A value of 50 or better is positive for the equity markets of that country and are shown in green on the chart below. Looks pretty good doesn’t it?

In Closing

 

A recession, which is more serious that a market correction does not begin without a degradation of economic indicators, so we do not appear to be at that point.

 

Equity markets have been extremely good and we expect 2018 will be another positive year, albeit with the potential of a pullback somewhere along the way. We also feel that it is likely now time begin to overweight international equities over both the US and Canada.

 

As always, if you have questions or would like to discuss, don’t hesitate to give us a call.