InnOvation Capital & Management, LLC
IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
APRIL 11, 2018
Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.
As we apprised you last week in IntelDigest, The Economy and Markets will be the primary topic of discussion throughout April. This issue, however, will be shorter than usual, as we attend to tax commitments on behalf of our clients.
So, we will concentrate on the near-term … what to expect over the next few months. In later issues, we’ll discuss prospects into 2019 and 2020.
The Age of Volatility
This long Bull Market, which began in 2009, has been longer than most. And, 2017 was a most unusual year, featuring abnormally-low volatility. Markets moved steadily Up, with nary a pause to rest. Everything seemed to be coming up roses!
But, everything changed in January, and volatility came roaring back. We have entered an Age of Volatility, where market corrections of 5-10% are expected to be a regular and normal occurrence going forward. As we stated last week:
The Age of Volatility will certainly last through the end of 2018, until the beginning of the next major recession. The “Melt Up” in equities is in the “Ninth Inning” … just a few more months of possible gains in select stocks. For the bulk of the investment markets, we are moving into a new era. There will be significantly fewer “trending” stocks and more “reversion to the mean.”
The path forward will feature choppy trading, extreme swings up and down, and headaches for “bulls” and “bears” alike.
Fundamentally Sound Markets
We still believe that the equity markets are fundamentally sound … here in the U.S. and in major economies around the world … and the “Melt Up” in the markets still has several months to run.
As recently as February 14 … after the first correction of 2018 … we wrote that “… certain factors support the continued “Melt Up” of equities, both domestically and internationally, for another few months.” Among those factors:
* low Interest rates continue to undergird the health of the equities markets
* world economies are stable
* strong earnings in the largest U.S. corporations
* positive technical indicators signifying continued strength … the Advance/Decline Line and market breadth moving up
Add to this the effects of the massive Christmas present which Congress handed to American companies in the Tax Cuts and Jobs Act of 2017 (TCJA). Financial results for the first quarter under the new tax regimen will be reported this month. The news is expected to be very good for U.S. equities.
Are U.S. Stocks Expensive?
* We have made this point on several occasions over the last few years:
Although stock prices have been at historical highs, they have NOT been overvalued, when ultra-low interest rates are factored in.
Now, we add two more factors which support the “value” of current stock prices:
* The aforementioned Tax Cuts, which will improve earnings for most American companies … by some estimates, the earnings of companies in the S&P 500 Index are expected to rise by 27% over the next 12 months
* The recent Corrections in the markets, which have brought many stock prices back to earth
As a result, one of the most prevalent measures of “value” used by investors … the Price/Earnings (P/E) Ratio … has fallen back in line with its 25-year average, based on estimated earnings in the coming year.
The P/E ratio measures the value of company stock by comparing the stock price (in the numerator) to the company earnings (in the denominator). The P/E ratio of U.S. stocks had climbed pretty high over the course of 2017, which caused concern among many analysts and investors.
However, 2018 has brought a significant change in this measure. Recent corrections in market prices have brought prices (the numerator) down, while the Tax Cuts are expected to bring earnings (the denominator) up.
So, the abnormally-high P/E ratios of 2017 are giving way to P/E ratios much closer to the long-term norm in 2018. Stocks which seemed “expensive” a few months ago now trade in a “reasonable” range.
U.S. stocks, as a group, now trade at the same forward P/E ratio as two years ago, in March/April of 2016. This measure of the “value” of these stocks remains the same. However, over the same period of time, the “price” of many of these stocks has moved much higher, bringing large gains for investors.
More next week ….