But with just a few weeks to go in 2017, the markets have already delivered a sled-load of gifts to investors. In October, the S&P 500, Dow Jones Industrial Average, and Russell 2000 indices all reached new highs. Corporate earnings growth has been strong for the year, with S&P 500 operating earnings looking to rise about 20% for the year.
This earnings strength provides support for an already optimistically-valued stock market, but it also helps maintains the over-extended valuations of many companies. The bestcase scenario might be for a leveling off of stock prices for a time until earnings catch up to the present high P/E ratios. Unfortunately, the collective market mind doesn’t usually act rationally. In addition, investors still have few opportunities to generate returns with their cash outside of equities. With analysts looking for another 13% increase in corporate earnings in 2018, valuations might not settle down any time soon.
The strength of the economy is providing much of the underpinning of the stock market’s gains, not only domestically but internationally, as well. Fidelity advised customers on October 9, 2017, that “The global economy is experiencing a relatively steady, synchronized expansion amid low inflation, with low risk of recession.” Developing markets stocks have performed even better than U.S. equities this year, following more than two years of lagging behind. The Eurozone is in recovery, and China’s rising import demands have bolstered trade with many of its trading partners as a result of its expanding economy.
Consumer sentiment in the U.S. ended October at its highest monthly level since the start of 2004, according to University of Michigan Survey of Consumers. The average index of consumer sentiment during the first ten months of 2017 has been the highest since 2000.
As the fourth quarter of 2017 begins, the bear case for the market continues to be weak though not entirely groundless. To wit: The prospects for meaningful tax reform look bleak to many, and the 2018 mid-term elections are shaping up to be the most contentious seen in the U.S. in some time. A new Fed chairman could shift monetary policy. The University of Michigan’s survey found that 65% of respondents expect stocks to be higher in one year, a level not seen since before 2007. Traditionally, this level of bullishness is seen as a bearish signal for the markets.
Before year-end, anything could happen, so investors are advised to take appropriate action to forestall the impact of a correction. Positions held at near-record high valuations should be thinned or protected with trailing stop-loss orders. Portfolio diversification should be reviewed with an eye towards including a healthy portion of defensive stocks.
And company quality must be maintained; while a rising tide lifts all ships, ships with leaky seams sink fastest when storms arrive. Find the best company opportunities for 2018 and beyond by subscribing to the SmallCap Informer today.
- DOUG GERLACH