2016 and 2017 have been quite the couple years for the stock market, with all of the major US indices reaching never-before-seen highs and rallies in just about every sector save oil and gas. With all this optimism in the market, it's only a matter of time before things decelerate or the market goes into a massive correction. However, not too many analysts are worried about a market meltdown in 2018, but perhaps they ought to be. There are quite a few market contrarians out there, and they have been making some noise and predictions in recent weeks.
(This is based on some market predicts from a recent piece on Investopedia, so be sure to check out more information there. Again, these are just predictions, nothing is certain until it has past. Also, these are not necessarily MY opinions on the market, but my goal is rather to show you that there are a lot of different opinions out there and it is important to hear all sides of the story.)
The Bull's Final Run
Investors should be prepared for a massive correction in the next few months; this is likely a market decline of somewhere around 10%. Stocks will face a lot of volatility as there ought to be one last big rally before the end of the year, and then they will ultimately crumble badly. An analyst recently spoke to Barron's and noted that stocks will likely experience a 25% decline in 2018. The analyst believes that a pullback of 6% to 8% in the S&P 500 Index (SPX) is already underway, and that the Russell 2000 Index could drop by 13% to 14%. After rebounding to new highs later in the fall, he expects the S&P 500 to close 2017 in the range of 2550 to 2600.
The Source of Safety? Technology Stocks!
Many firms believe that techology (growth stocks) are one of the most important places to invest in the coming months and years, despite market volatility. Many hedge funds and mutual funds biggest bets are in technology, semiconductor equipment, data processors, IT consulting, and electronic manufacturing services. However, it is unclear if security can be found in the so-called FANG stocks, which are Facebook Inc. (FB(), Amazon.com Inc. (AMZN), Netflix Inc. (NFLX), and Google parent Alphabet Inc. (GOOGL). Analysts do not seem to believe that tech sector valuations are out of hand, even including the FANGs, and see a positive in the fact that the price to cash flow ratio for the S&P tech sector has been virtually unchanged over the past four years, at a value of about 15 (which is roughly in-line with the valuation of the market).
Market 'Top' in 2018
The market ought to have a big correction (pullback in prices) sometime in 2018, but it's just a matter of determining how soon into the year this will happen. Current negative indicators include a slowdown in the auto market, a cyclical peak that's approaching in single-family housing, and a slowdown in annual non-farm payroll employment growth, which normally precedes the onset of a recession within 12 months. Additionally, there are negative real, inflation-adjusted, interest rates for 8 of the last 9 years, which could ultimately lead to a draw away from equities and into US treasuries since the yields are poised to be better.
Investment Math Than Cannot Be Denied
According to Leuthold Group CIO, Doug Ramsey, based on market history going all the way back to 1880, a theoretic balanced portfolio that has been 60% in S&P 500 stocks and 40% in 10-Year U.S. Treasury Notes has produced an average annualized return of 8%, noting that this is a common target for pension funds. In turn, that 8% breaks down into 4.1% from dividend and interest income, and 3.9% from capital appreciation, he adds.
Today, however, "a record combined overvaluation" of both stocks and bonds mean that a 60/40 equity/debt portfolio is yielding only about 2.1% today. "That is inescapable investment math that challenges the bulls," he asserts, forecasting that investors will struggle to generate an average annual return of 3% to 4% over the next ten years for such a balanced portfolio.
Despite all this, billionaire investor, Warren Buffett remains positive on the stock market, and he believe that valuation levels are far better by historical standards than bonds investments now. We will talk about Warren's view in the coming weeks.
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