Summary of our thoughts at the end of the 4th quarter of 2017


U.S. stocks have been supported by robust earnings, low stock market volatility, quiet inflation, and low long-term bond yields – all in the context of unprecedented central bank policy that has lasted for several years.

The world’s economies are now growing in sync, the U.S. labor market is relatively tight, and Fed monetary tightening is underway. As a result, the U.S. treasury curve is flattening and the credit cycle is peaking.

While U.S. stocks remain at lofty valuations and markets are hitting fresh new highs, much of 2017 was spent in a calm that hadn’t been seen since the 1960’s. Nobody can predict stock markets with 100% certainty. However, we would expect volatility to reemerge in the coming year and believe a 5-10% correction is healthy.

Importantly, the indicators of a bear market, corresponding credit crisis, or recession are not present. However, as we believe we are in the later phase of the bull market, we are mindful of risk. Our focus is on companies with strong balance sheets, minimal refinancing risk, and high earnings visibility. At the same time, as most asset prices have high valuations, we search for relatively inexpensive stocks in a world where value is scarce.

The combination of economic strength, firming prices (inflation), and a less dovish Fed is likely to produce higher interest rates across the curve. During periods of rising interest rates, yield curves flatten and value stocks tend to outperform growth.

In the meantime, the complete earnings benefit from the tax reduction and regulatory roll-backs is massive. Barring a political shock at home or abroad, the positive effects of a pro-business Washington could very well lead to a strong stock market throughout 2018 and perhaps into 2019 as well.

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