The Case for a Raging Market in 2017
Trumpeting a new boss in the White House wasn’t the only cause of the recent spectacular rise in the stock market. Several economic indicators improved in the fourth quarter. Nicholas Vardy wrote,
Consumer confidence stands at its highest level since August 2001. The unemployment rate is at nine-year low. The U.S. economy is close to full employment. S&P 500 earnings are coming out of an earnings recession, and are expected to grow by double-digit percentages in 2017.
The supply of US dollars accelerated during late 2016 with October’s year-over-year percentage increase in the money supply hitting a 46-month high of 11.2 percent. The YOY growth rate fell slightly to 10.3 percent in November.
This comes after a long period of relatively sedate growth in the money supply through most of 2013, 2014 and 2015.
The recent surge in money supply growth suggests that the likelihood of an economic contraction in the near future has been reduced, with the next downturn being pushed out further into the future.
And Gavyn Davies over at the Financial Times wrote that the whole world is doing better:
As the global economy enters 2017, economic growth is running at stronger rates than at any time since 2010, according to Fulcrum’s nowcast models. The latest monthly estimates (attached here) show that growth has recovered markedly from the low points reached in March 2016, when fears of global recession were mounting.
The stats have the feel of a budding expansion, not the signs of an impending recession. Could it be that we won’t experience another recession for a long time because the very lame expansion we have endured since the Great Recession has performed the healing work of a good recession, which is to clear out bad investments and free up capital for investment elsewhere? If so, then we need to be investing in cyclical stocks and many people have been.
But for investors this isn’t particularly good news because we never got the big stock market crash that comes with a recession and makes investing in the early part of the expansion so lucrative. It means that we start the bull market with very high valuations instead of the typical low ones. Most of the gains investors make right after a recession comes from the transition from low PE ratios, that were due to pessimism, to average and then high ratios near the end of the expansion.
So we are left with just the growth in profits, assuming PE ratios (risk tolerance) stay the same. That may be the case because the number of listed companies on the exchange is down by a third. We have lost almost 50% of the publicly traded companies that were listed in 1997. With fewer companies issuing stock, investors will bid up the prices of those that remain and keep PE ratios on a permanent high plateau. And until interest rates rise dramatically there are no good alternatives to the stock market.
Unless risk tolerance grows, stock prices will be able to grow only at the rate that profits grow. Some expect that to be about 10%, which wouldn’t be a bad return for an aging bull market.
That scenario is possible. After all, the Fed’s creative policies for the past eight years have plunged us into uncharted waters so no one should be too confident about the future. Still, I’m not convinced. It would mean that we have stumbled into a way to defeat the business cycle and that reminds me too much of1999 when mainstream economists printed the obituary of the cycle. Then the 2001 recession and start of a mean bear market jumped up and bit us.
Originally published on ABCT Investing.