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Written by: Chaikin Analytics
1. The bull market is maturing, but is not over yet
The adage that “bull markets climb a wall of worry” held true in 2017, as political strife in Washington crescendoed to a level not seen before, geopolitical factors worsened, and the rally to new highs brought out the bears in the media. Ultimately, fundamentals drive stock prices and with the U.S. economy on solid footing, coupled with ongoing growth in both top-line revenues and bottom line earnings, fundamentals are supportive of continued upside for equities.
History indicates bear markets rarely materialized, while the economy was expanding. We believe it is unlikely this time will be different. Amid lower corporate taxes and easing regulatory burdens, the earnings picture continues to look good for U.S. stocks, which we believe will be a continued tailwind for higher stock prices.
The S&P 500 is on a torrid pace. The last time the U.S. equity gauge benchmark declined on a monthly basis was November 2016, and the last 5% decline was back in June 2016, during the Brexit imbroglio. This year, we believe there are likely to be one or two declines of 5% to 10%, but in the context of a positive year, those declines will be buying opportunities.
Overall, 2018 should be a continuation of the earnings-driven upside delivered in 2017, supported by expanding top- and bottom-line numbers.
S&P 500: positive Sales Surprise (% of Companies)
2. Picking winners/avoiding losers is increasingly important
In any environment, it is important for investors to identify winning stocks, while avoiding losers. That is increasingly true in an aging bull market. Different factors become important to identify in a mature bull market, and finding stocks with a good growth to value trade-off will take on more significance. We believe having a repeatable and consistent process is the key to making money over time, especially in late-stage expansions.
Historically, technology and industrials are among the sectors that performed well in mid-cycle stages while materials and utilities lagged during those periods. As the cycle advanced to its later stages, economically sensitive sectors, such as energy and materials, performed well, as did defensive groups, such as consumer staples, health care, and utilities.
3 Trees don’t grow to the sky. Neither do stocks.
Much of the 2017 upside in U.S. equity markets was attributable to the FAANG stocks (Facebook, Amazon, Netflix, and Google). These are incredible growth stories with solid management teams, but while we believe earnings and revenue growth is likely to continue for these companies, regulatory headwinds linger. At some point, popular stocks, like the FAANGs, become fully priced, and 2018 may be that year. We believe that 2018 will bring more differentiation to stock performance and the overall returns of the market will be less dominated by a few mega-cap stocks.
4. Value looks to beat growth, and size matters
Investors look at many style-based factors to see what areas of the market have been outperforming or underperforming. Factors such as size, growth versus value, beta, momentum and dividend yield, are all cyclical, with leadership dominating for a year or two, and then lagging for a period of time. Last year, the growth factor dominated value, while large caps topped smaller stocks. For example, the Russell 1000 Growth Index gained 30% last year, or more than double the 13.5% returned by the Russell 1000 Value Index.
Value has been trailing growth for two years, due in large part to technology's leadership. We believe 2018 will bring a reversal of value and the small-size factors' laggard ways.
As this bull market ages, we believe investors will pick up cheaper segments of the market, bidding up value stocks relative to growth names. Additionally, there are some great opportunities in small caps, with the new corporate tax rates benefiting smaller companies, as they can’t play the same tax games as large multi-national companies who use overseas subsidiaries and other tax-avoidance techniques to lower their overall tax rates. Furthermore, small caps have historically outperformed large caps when interest rates rose.
5. Embrace solid fundamentals
This is the right thing to do all the time and is not just a 2018 story, but it takes on increased importance in the late stage of a bull market. The old adage “a rising tide lifts all boats” can be applied to stocks. In new bull markets, many investors simply “buy the market,” but as the bull market advances, there are potential rewards for tactical investors. In 2018, it will be critical to buy stocks that have solid growth prospects, balanced with reasonable valuation factors and encouraging technicals. Fundamentals drive stock prices, so focus on stocks with strong fundamental factors in strong sectors and industries.
All investments are subject to market risk and will fluctuate in value. Liquid alternatives are alternative investment strategies that are available through vehicles that provide daily liquidity, such as mutual funds and ETFs. Alternative investments are speculative, entail substantial risk, and are not suitable for all clients. Alternative investments are intended for experienced and sophisticated investors who are willing to bear the high economic risks of the investment. Investments in absolute-return strategies are not intended to outperform stocks and bonds during strong market rallies. Hedge funds and hedge fund of funds can be highly volatile, carry substantial fees, and involve complex tax structures. Investments in these types of funds involve a high degree of risk, including loss of entire capital. Investments in derivatives often involve leverage, which may increase the volatility of the investment and may result in a loss. High yield securities (junk bonds) have speculative characteristics and present a greater risk of loss than higher quality debt securities. These securities can also be subject to greater price volatility. Investing in smaller companies involves special risks, including higher volatility and lower liquidity.
The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results. New York Life does not provide legal, accounting, or tax advice. You should obtain advice specific to your circumstances from your own legal, accounting, and tax advisors.
IHS Markit Purchasing Managers’ Index (PMI) is based on monthly surveys of carefully selected companies representing major and developing economies worldwide.
S&P 500 is an index of 505 stocks issued by 500 large companies with market capitalizations of at least $6.1 billion.
Russell 1000 Growth Index is an index of approximately 1,000 of the largest companies in the U.S. equity market.
Russell 1000 Value Index refers to a composite of large- and mid-cap companies located in the United States that also exhibit a value probability.
Marc Chaikin, Chaikin Analytics and Chaikin Power Gauge are not owned, operated or affiliated with New York Life Investments LLC or any of its affiliates.
MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of the IQ Hedge Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.