December 8, 2017

L&S Risk Pulse™ Score

Medium +

Core economic indicators are healthy, but markets indicate potential near-term volatility and/or mild correction. Valuations are trending high.

L&S Risk Pulse™ Insights – “Seasonal Patterns Have Not Worked”

General Comments

There is an old Wall Street adage to “sell in May and go away.”

The idea is supported by the fact that the period from May through October tends to have lower returns than the other months of the year.  Further, August, September, and October have the lowest monthly returns, with September being the only month that, on average, has been a down month.  Some people take this to mean that investors can raise cash on May 1st and reinvest on November 1st, but that is not true.  The data suggests that the returns from November through April represent about 65% of the returns for the year while the months from May through October generate the remaining 35% of returns.

Seasonal patterns did not work this year.  There was no weakness in August or October.  September was not a down month.  In fact, there has been no down month so far in 2017.  Does that make you worry about December?  It shouldn’t.  Since 1950, December has never been a down month, although seasonal patterns have not worked this year…

Data Points and Global Economic Indicators

The fact is that the economic data supports the solid gains in stock prices so far this year.  Earnings gains have been solid, and projections are for further growth in earnings as we look ahead to 2018.  The potential for a corporate tax cut will increase earnings even more next year.

Consumer confidence remains high, as does small business confidence and CEO confidence.

There are no signs of credit problems anywhere to be seen.  We look at credit default swap costs, high yield spreads, loan delinquency rates, lending officer ratings, and bank charge-offs, and there are no signs of impending credit problems.

Purchasing manager reports are strong, and have strengthened in many parts of the world.

Our two best indicators for the beginning of a recession continue to suggest that the next recession is unlikely to occur in 2018.

Many investors are concerned that this expansion, one of the longest on record, is close to its finale.  We must caution that, so far, expansions have never died of old age.  They end due to policy errors or by severe external shocks, such as the overnight doubling of oil prices.  While an external shock cannot be ruled out, we do not see the Fed or the government as having made a policy mistake that puts this expansion in jeopardy.  That may change as the membership of the Federal Reserve Board is undergoing dramatic change, but so far, our expectation from Jerome Powell, the President’s appointment to lead the Fed, is a continuation of the current modest pace of interest rate hikes.  These actions are supported by a very low rate of inflation, and interest rates that have stayed remarkably low.

The data supports the continuation of the synchronized global growth we have been writing about for several months, and we have no reason to suggest any change is forthcoming.  If anything, the economic data has strengthened over the past month.

Do not for a moment think that we see the world through rose colored glasses.  That is simply not true.  We continue to look for signs of risk, but so far we see very little that gives us cause for concern.

Conclusion

We remain optimistic regarding the prospects for financial markets as long as the music continues to play.  We will continue to look for signs that risks are rising, although we recognize that the music is still playing, and will probably do so for some time.  Until the data suggests otherwise, we remain fairly fully invested in the sectors that we feel will best participate in the global economic growth currently occurring.

Further, we strive to be selective and focus on sectors and securities that are better poised to take advantage of market conditions as we see them.  The music will stop when investors’ and money managers’ biases change, and that will occur when the underlying fundamentals change or the price action of the market changes.