Market Update (3/7/2018)

Index   Close YTD % Chg
DJIA Dow Jones Industrial Average (30 stocks) 24801.36 0.33
DJ TRAN Dow Jones Transportation Average (20 stocks) 10408.88 -1.92
DJ UTIL Dow Jones Utilities Average (15 stocks) 664.80 -8.10
NASDAQ Nasdaq (about 3300 stocks) 7396.65 7.15
NYSE New York Stock Exchange Index (2800 stocks) 12707.01 -0.80
AMEX American Stock Exchange Index (336 stocks including ADRs and MLP) 2487.59 -6.53
S&P 100 Standard and Poor’s 100 Index (102 stocks, 2 stocks have 2 asset classes) 1201.86 1.58
S&P 500 Standard and Poor’s 500 index (500 largest companies in the US) 2726.80 1.99
RUS 2000 Russell 2000 (Bottom 2000 smallest stocks in the Russell 3000 stocks) 1574.53 2.54
10 YR BOND Rates on 10-year Treasury Bond 2.88 19.50

What do I think of the markets (meaning S&P 500 in general)?

The S&P 500 is showing a typical performance for 2018 after the steep correction (over 10 days) of this past February.  The correction reminded investors that stocks do not go straight up.  The return of volatility to the market is both a good thing and a cause for worry.  It is a good because it wrings complacency and excess out of the markets, while it is a bad because bear markets (losses of 20% or more) have been preceded by periods of elevated volatility.

In general, the markets remain overvalued given conventional metrics such as P/E  ratio (Price-to-Earnings Ratio in other words the cost in dollars of $1 of earnings) is now at 32 with a historical mean and median at 16.83 and 16.15 respectively.  We would need earning to increase substantially or prices to come down for the market to get back to within 50% of historical valuation band.  It is likely that the combination of the two will happen, however, this adjustment  to a reasonable valuation can also happen with a sideways market while earnings grow (flat P and growing E).

{The Tobin’s Q ratio is a ratio that the combined market value of all the companies on the stock market should be about equal to their replacement costs.  The Q ratio is calculated as the market value of a company divided by the replacement value of the firm’s assets.  For example, a low Q (between 0 and 1) means that the cost to replace a firm’s assets is greater than the value of its stock.  This implies that the stock is undervalued.  Conversely, a high Q (greater than 1) implies that a firm’s stock is more expensive than the replacement cost of its assets, which can imply that the stock is overvalued. }

It is impossible to time when the correction will happen; therefore it is important to stay invested at an appropriate risk level while being mentally prepared for volatility and periods of steep corrections.

The excessively high debt level and margin rates leave the market susceptible to steep drops as a series of losses can cascade very quickly and trigger margin calls.

What are investment themes for the rest of 2018?

We believe that 2018 will continue to be the year for:

  • Technology-Biotech/healthcare-Commodities
  • M&A will pick up as the results of the tax cut driving prices higher in these sectors
  • Geopolitical risks and Trump intervention will continue to remain important factors

What is likely to happen in the next two years?

After looking at several forecasts, I tend to agree more with an artificial intelligence (AI)-based model developed by EidoSearch, which puts its 2018 forecast as follow:

There is a 70% chance that the Dow will be between 21,561 (down 11.6%) and 30,920 (up 26.8%) with an expected value of 26,284 (up 7.8%).  This forecast bodes well for the stock market, but it does not give much guidance about the likely path of the gains.  Unfortunately, the model also predicts with a higher confidence a bear market in the next 24 months. I will take the long term forecast in strides and focus on the positive market outlook in the next 12 months.

What are my views on bitcoin (crypto-currencies)?

First, I don’t think it is a currency or will ever be treated as a currency because I cannot see how governments (more so the US government) will relinquish any of their three fundamental reasons to exist:

  • Make coin / print money (control of the economy)
  • Declare War (control of war and peace as well as security)
  • Sign treaties (control diplomacy)

As a store of value like gold, a couple of “crypto-currencies” will most likely do well (or survive) in the future.  However, it is difficult (or impossible) to figure out which ones will survive and be widely accepted as a store of value. As with commodities like gold, it is wise to devote a small percentage of one’s asset (perhaps less than 1%- amount that can be lost without any worries) to the asset class. I think the odds of bitcoin doing well are better than those of winning the lottery; however, it still is a gamble.

What are my views on oil prices?

I tend to stick to the oil price forecast of the US Energy Information Administration which have been somewhat accurate over the years. It predicts that oil prices will remain stable for 2018 while drifting lower (from $60/barrel to $57/barrel in 2019).  The major oil companies will stabilize with these prices; however, the upside in the energy sector is limited.


What are my views on interest rates and inflation?

Inflation will continue to pick up at a brisk pace along with economic growth.  As the Fed becomes more aggressive, the market will perhaps correct and return to a reasonable range of historical values.

What are my views on general 2018 Outlook?

Expect volatility! Painful periods of steep declines! We likely will end the year flat to slightly positive with difficult periods ahead. Geopolitical events will have a greater impact on the markets increasing volatility.  We should expect sharp rallies and pullbacks in the stock market.  In the end, it is likely to be a positive year (because the economy is still growing)  although with a lot of pain along the way.  It is most likely going to be a marathon!