Short Term Momentum is strong
The Trump rally has certainly been a nice surprise to close the year. The current momentum is strong and the general mood for investors appears to be very optimistic. Generally, investors are wise to invest in the direction of the trend. For the short term, we wholeheartedly agree. We suspect that the last 30 days will carry over into the start of the new year and wouldn’t be surprised to see a strong start to the year for US stocks.
Optimism is too high
It should be noted that optimism is uniquely high in the market at the moment. One way to measure investor optimism is by looking at the “crowd sentiment poll”, a poll that asks everyday folks about their view of the economy. Ned Davis Research, a well known, third-party research firm that we follow, has some interesting numbers on extreme optimism.
When the Ned Davis Crowd Sentiment Poll measures a reading above 61.5%, the next 12 months are subpar. In fact, when the Poll measures a reading above 66, the average return is -7.7% annualized (results 1995-2015).
As of December 20th, the NDR Sentiment Poll reading was registering extreme optimism with a recent reading of 70.19, the highest since the peak of the dot.com bubble in 1999.
Be careful. Optimism is generally the highest at market peaks.
Stock investors are paying a premium
While we do anticipate above average earnings growth for companies in 2017, we must also admit that the market has most likely already factored in those results. One way to gauge the attractiveness of stocks is compare their current price to their true operating earnings. Currently investors are paying roughly $24 dollars for every $1 of “operating” earnings for stocks in the S&P 500. On average, any reading above 18.2 is considered high (according to Ned Davis Research). Going back to 1930, any time investors pay more than $18.2 per $1, the following 12 month return has averaged -2.6% annualized. Again, not a great sign.
While we don’t see grounds for another 2008-2009 scenario, we do urge investors to reign in the optimism for 2017 and to exercise caution. We tend to favor higher yielding income investment strategies and see little room for further price appreciation in US stocks.
We do see opportunities ahead.
We reiterate our outlook from last month:
In general, we tend to favor alternatives sources of return, such as high yield bonds, floating rate bonds, gold, real estate, and convertible bonds, as we believe the risk / reward trade-off is more favorable in those asset classes.