Consensus is building

Equity markets continue where they left off last year, the FTSE 100 has managed to break the 7500 ceiling, despite the pound continuing to make ground against the USD. US markets once again hitting new year highs. The Santa rally, which paused for breath in the last few days of 2017, has continued into the new year. The start of the month sees the release of the previous months purchasing managers surveys, aside from the UK Manufacturing PMI, the surveys have generally met or slightly beaten expectations. It is often said that the month of January can set the tone for the year. It would certainly have worked well last year. In January we saw gains in the S&P 500 of just shy 2%, compounding that through the year gets you to just about the performance for the year.

Cyclical stocks remain in favour as the more defensive sectors such as the utilities underperform the broader market. Investors continue to back the idea that inflation will creep back into the global economy. Counterintuitively to that there does appear to be a consensus growing that Goldilocks’ porridge will stay just right in 2018. As Barron’s points out there have been several occasions in the past years where economists have falsely raised the spectre of inflation reappearing.

Barrons provide an interesting chart highlighting the impact various rates of inflation have had on equity multiples over the past 70 years. Where we are now 0-2 % inflation, supports price to earnings multiples of 18x, currently what the S&P 500 trades at. If inflation expectations were to change up a notch to 2-4 pct, sees that ratio fall by about a point, which would, in theory, mean a correction of circa 6% in the S&P 500.

Last night the Fed released the minutes of their December meeting, where they agreed on the last of three hikes in the year. We have mentioned in these blogs the flattening of the yield curve as a result of the Federal Reserve raising short-term interest rates. The concern is that a flattening yield curve can be a lead signal that an economy is at risk of slowing. At present, the Federal Reserve members seem relaxed about yield flattening, as the members feel that further gentle rises will be appropriate in the coming year.

One thing that was interesting last year, the biggest correction in US equities which saw the Vix index has its 10th largest one day rise in history, appeared to have no attributable event associated with it (Courtesy of Strategas charts).

Posted on January 4, 2018 .