What’s Past is Prologue for Markets in 2018

Bryan Perry

Bryan Perry has three decades of experience inside Wall Street. Bryan’s experience has given him a unique approach to high-yield investing.

Heading into any new year, there is a constant drumbeat by the investment community to demand fresh strategies that will catalyze portfolios when the calendar turns over to Jan. 1.

The usual suspect topics, such as “Dogs of the Dow” or “5 New Year’s Investing Resolutions,” tend to stray from the reality of where current capital flows are targeting. With the final trading day of 2017 being last Friday, the S&P 500 finished very close to the 2,700 mark, resulting in solid gains of more than 20% for the year.

The Nasdaq has fared even better in 2017, posting a gain of 30% with the FAANG stocks of Facebook, Apple, Amazon, Netflix and Google (Alphabet) having another banner year of performance. It should be no wonder that the month of December has seen some aggressive profit-taking in tech as fund managers perform their year-end rebalancing of portfolios, pairing off winners with losers in order to smooth out tax efficiency.

Indeed, the major averages put on a stellar performance in 2017. However, with tax reform having passed, interest rates still at extremely attractive levels for both businesses and consumers, and stock buybacks and mergers and acquisitions activity remaining robust, the path of least resistance for the stock market is higher. The primary bull trend remains intact, with visibility for the next three to six months being fundamentally and technically positive for stocks.

During the month of December, the most notable developments were the bump in Treasury yields that set financials in motion for new highs and the sharp spike in the energy sector. The Fed raised short-term rates and laid out a dot plot plan for next year that includes three more rate hikes. This news was all that was needed to fuel a strong rally in financials, which I believe will last well into the first half of 2018.

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WTI crude prices bumped up against $60/bbl. and the energy sector got a slingshot move off the low end of a multi-month range. We saw the major integrated oils and refiners vault to new 52-week highs. This trade caught most investors flatfooted, having moved from the energy patch months ago on the notion that coordinated production cuts would provide only temporary relief from what is still perceived as a glut in global crude supplies.

There is still a lot of potential production that is currently idle, and which could come online and force prices back down. The larger investment theme of “synchronized global economic expansion” has kept a bid under crude, betting that rising demand will soak up the threat of new supply.

My current view on energy is that while the rally has been nice, the sector is overbought and due for some consolidation. I believe crude prices, while at the upper end, will stay range-bound and are likely to soften heading into spring save for geopolitical or accidental large-scale disruptions. Consider this week’s explosion in one of Libya’s pipelines that took 70,000-100,000 barrels of daily production offline as an example.

Going forward into early January, the first two weeks of the new year is always a toss-up as to where short-term sentiment will dictate the market’s direction. However, I expect strong representation from leading stocks in the technology, financial, industrial and aerospace/defense sectors to lead the market higher as fourth-quarter earnings season approaches.

If this sounds familiar, it should. Momentum for these sectors will take a breather from time to time, as has been the case in December. The potential still exists for further strong gains in revenue and earnings growth, coupled with solid forward guidance, to guide fund flows into the best-of-breed names that have dominated trading for most of 2017.

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Looking at other notable sector moves, my take on the rally in materials and commodities is that we’re seeing a cyclical bull market within a long-term secular bearish downtrend. Rallies should be sold into when technical indicators are flashing overbought readings, married with a measure of caution on buying future pullbacks.

Gold prices have been rallying of late, challenging $1300/troy oz., with the U.S. dollar trading lower as the federal deficit is projected to be higher this year due to lower anticipated tax receipts from the new 21% corporate rate. It is hard to ascertain anything larger from this development, as the rally in gold might be in reaction to the volatility within the Bitcoin space.

Speaking of Bitcoin and the whole cryptocurrency revolution, I’m a believer in the transformational change taking place regarding blockchain technology. Currently, the technology is primarily used to verify transactions within digital currencies, though it is possible to digitize, code and insert practically any document into the blockchain. As to the various currencies like Bitcoin, Bitcoin Cash, Ethereum, Litecoin and the rest, expect to see 30-50% swings in price, with the broad direction being higher simply because they are more buyers than sellers in the marketplace, at least for now.

Other blockchain protocol platforms such as Ripple are a new breed of open payment network providers that are seeing rapid adoption by credit card companies and financial organizations focused on seamless transactions. Ripple provides one frictionless experience to send money globally using the power of blockchain. Hence, Ripple and other blockchain tech companies might be the larger and more investable theme within the broader crypto-asset revolution that was clearly the biggest story of 2017.

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As to whether one buys into the crypto-asset space as a store of value or as it takes on the role of global money, it’s still too early to know the implications for these various currencies as the rules, regulations and restrictions are still being defined. My advice is to not allocate more than 1-2% of a portfolio to Bitcoin et. al. exposure.

Looking ahead, with rates expected to rise, financials should lead early in 2018 with information technology regaining its upward momentum and its rightful place as market leader. Industrial themes will continue and increased defense spending supports more gains for that sector as well.

It is my view that emerging markets and European markets will follow the direction of the fortunes of the U.S. market. A lower dollar, coupled with the global reflation trade, bodes very well for top- and bottom-line growth for U.S. multinational companies, and their stocks should perform well.

Finally, there is no magic number I’m looking for the S&P to trade up to by this time next year. A simple 12% move up would take the S&P to 3,000, a level that I find very achievable. For my latest income and trading strategies, go to my website and check out Cash Machine to give your portfolio a competitive edge as we head into 2018.

 

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MARK SKOUSEN, PH.D. is a financial advisor, professional economist, university professor, and author of more than 20 books.

For the past 30+ years, Dr. Skousen has been the editor of the award-winning newsletter Forecasts & Strategies. He is also the Chairman of the

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