Despite dipping for the line January 2018 was a seriously impressive month for global stock markets. Mid-month peaks saw excited commentators reaching for words like unprecedented and unsustainable – both of which are wrong – and combing record books, resulting in all kinds of fun facts, which tell us a lot more about where we’ve been rather than where we’re going.
Table 1 below shows how stock markets ended the month as well as what they were at their peak during the month:
Notwithstanding the drop from its peak the US result was the eighth best in the last 50 years, so there have been plenty of precedents, and in every one of those other seven years the S&P 500 ended the year higher, by an average of 22%, so it’s possible it could be sustained as well.
It pays to bear in mind that those kind of data are only so useful, after all, each period will have its own characteristics with respect to the level of inflation, unemployment, domestic and international growth patterns – all kinds of things that go together to influence financial markets. Rules are made to be broken.
Still remarkably calm
Another interesting stat is the US market has now gone the longest ever without a 3% correction at some 450 trading days and is close to setting a similar record in relation to a 5% correction. While that reflects an extraordinarily calm market unfortunately it tells us nothing about how long it will go on for or what it will be like when volatility eventually returns, as it will.
In fact, the US VIX, frequently referred to as the fear index, having averaged 11.1 for 2017 and recording the lowest 85 days in its history crept up almost 40% over January – see chart 2.
Chart 2: The US Volatility Index (VIX), aka the ‘fear index’,
rose almost 40% over January
So why the strong start to the year? It’s not just tax cuts
Again, there’s a ‘narrative fallacy’ out there, that’s when a commentator gets a microphone shoved under their nose and asked ‘why has the market gone up today?’ and they clutch for the nearest straw, which in this case has been US tax cuts. Yes they’ve contributed but there’s more to it than just that. The French market was up 3.2% and Italy a mighty 7.6% and they haven’t had tax cuts.
The oil price has jumped 55% from its lows of last year and the US$ has dropped 14% in the last 12 months, which helps a bunch of US companies. Importantly as well, as the New York Times pointed out, for the first time since the GFC every major economy is expanding at once – see chart 3.
Chart 3: there’s synchronised global expansion for the first time since the GFC
Critically, forecasts for 2018 US corporate earnings growth have risen from 12% to 18%, and that 30% revision is the strongest in 20 years – see chart 4. It means the S&P 500 is now on a PE of 18.4 times, which is still comfortably above the long-term average of 15.7, but then again, core inflation is still below 2% and real earnings growth is double the long-term median. Whether the US market is good value is another debate, but you can see why it’s gone up.
Chart 4: 2018 earnings forecasts have been revised sharply higher
Institutions: risk on
BAML (Merrill Lynch) does a monthly survey of 200 global fund managers, with the latest covering to the start of 2018. Although it’s backward looking it offers insights to the massive money flows coming from institutions which are so influential in global financial markets.
The survey showed institutional cash levels are the lowest in four years and the allocation to global equities is the highest in three years. Kind of counter-intuitively, the lower the cash levels and the higher the equity allocation, the less positive it is for the outlook for share markets, because it means the instos are running out of fire power.
For some perspective, back in February 2016 at the end of the last correction, instos were 5% overweight equities, now they are 55% overweight, which is 1.1 standard deviations above the long-term average. The big flows have gone in to emerging market equities, which have swung from 6% underweight in January 2017 to now 41% overweight, which is almost a seven year high. Interestingly, US equities, which have way outperformed European equities over the past year, remain significantly underweight.
US bond yields are on the move
Reflecting the big risk on move, institutional allocations to bonds dropped to 67% underweight in the BAML survey, which is a four year low and 1.2 standard deviations below the long-term average. A whopping 78% of fund managers believe interest rates will be higher over the next year (interest rates move in the opposite direction to bond prices).
US bond yields have already seen a sharp rise. Over the past four months 10 year Treasury yields have risen from 2% to 2.7%. In percentage terms that’s a significant move.
And just like the US share market has had a remarkable run of steadiness, Bespoke Charts pointed out there has never been a time in the two-year Treasury’s history where it has been this far above its 50-day moving average for this long – see chart 5.
Chart 5: the steady rise of the US two year Treasury’s yield has set new records
Australia: left behind?
Compared to its international peers the ASX200’s performance of -0.4% over January was kind of disappointing. However, for a bit of context, it had risen some 9.5% in the three months to 9 January – see chart 6. Perhaps it was taking a well-earned break ahead of the company reporting season which kicks off in earnest next week.
Chart 6: the ASX200 rose 9.5% to early January and then ran out of puff
You’d rightly ask what the takeaway is from all these fun facts. Unfortunately not a lot. For sure we’ve had a strong start to the year and volatility is still very low, but what that means for future returns is anybody’s guess. You might recall the start to 2016 was kind of the opposite to this year, being one of the worst ever recorded, but since that bottom in February the world equity index has risen almost 50%. Not many people would have picked that.
Investing by just focusing on past data is like trying to drive a car by looking in the rear view mirror.