Every day seems to bring something new, and the initial response is often: “did that really happen??” The answer continues to be yes. This calendar year of 2017 has been like nothing I’ve ever seen. I’ve said that many times. I believe I think it daily.
December started out with a bang after a strong finish to November with the DOW and S&P exploding higher yet again to fresh new highs. Creeping closer to a tax deal in the Senate was the trigger as stocks accelerated higher to the 11th month’s close. A vote might come tonight. Ultimate passage is still not certain, but it’s getting more and more likely. But the bottom nearly fell out of the Stock Market when former National Security Advisor Michael Flynn pled guilty in court today to lying to the FBI. It sent the Dollar lower, Gold higher, and money flew into Bonds. The read-through is Flynn might have a lot to say that could be damaging to the Trump administration, or even the President himself. The sell-off accelerated in our mind because the prospects of a tax deal might have been frozen in light of the Flynn news, with the idea that some in Congress might decide to disassociate themselves from the White House backed plan. Selling accelerated, but it was the lack of buying which seemed to cause the initial free-fall. Bids just vanished. Friday saw the biggest decline in 6 months. As time went on and word started circulating that the votes were there for a Senate passage, buyers stepped back in and the Market swiftly moved off its lows.
It’s been just an unbelievable run with no mean reversion since the Summer. The Stock Market just hasn’t wanted to go down. It’s impressive but not healthy behavior. The S&P 500 has now gone 64 straight weeks without a 3% decline. That is the longest stretch since 1965. But this is like no other year in so many respects. This is a very rare situation in 2017 with this Market resilience. “Buy the Dip” has been the rallying cry and it has absolutely worked. Consider the explosive strength this week, despite the North Korean missile launch and claim that their nuclear program is complete. The Market just doesn’t care. Fed Chair appointee Jerome Powell faced testimony on Capitol Hill but his confirmation isn’t really in question. His comments about regulation and monetary policy were very consistent with Janet Yellen’s, which the Market really likes. Financial Stocks led the rally with a seemingly much more supportive environment ahead.
It doesn’t seem to matter that North Korea is fully equipped with a nuclear arsenal nor the fact that our Secretary of State is reportedly, not just going to be run out, but publicly shamed first. The Market just doesn’t seem to care. It’s just mind-boggling. But the momentum has been undeniably strong. Fighting the tape has been painful and damaging to portfolios in 2017. Our defensive position in August worked for 10 days, but the Summer sell-off was less than 3% in size. We held our defensive position into the Fall season, which turned out to be unnecessary despite so many concerning developments. We put fresh money back to work a few weeks ago to capture the continuation of the rally. We continue to think judiciously and act methodically as we navigate this difficult Market environment.
Despite no overall Market correction, there have been plenty of micro-corrections under the surface. There has been a major switch though, with Tech for the first time showing real weakness while Financials and Energy have taken the lead. Generally put, Tech had a tough week within a fantastic year. Strength has rotated but the price-weighted DOW just won’t go down. Banks and large financial institutions stand to benefit from this corporate tax plan and the general pro-growth policies, which has helped propel their stocks higher. Tech titans have relatively low effective tax rates and don’t stand to benefit as much. This supports the rotation of strength from Tech to Financials.
There are just too many things out there that could derail this rally at any moment. This Market is fraught with risk. The issue we’ve all been dealing with this year is how much is real risk vs perceived risk? Perception isn’t always reality. It certainly is in the court of public opinion. But, for whatever reason, the Market has looked past every potential problem from Washington to Russia to North Korea. Nothing has been resolved. We started out the year anticipating a robust acceleration of earnings growth, which is the biggest driver of stocks. It happened. The global economy has strengthened too. It is on track for the best year since 2010. The US economy is growing over 3%, the fastest in 3 years. For the first time in 10 years, every major global economy is growing. That is such an important factor. International Markets are in catch-up mode with many major international indices at the same levels they were in 2014. We like this theme. Corporate earnings and the global economy are critical drivers for stocks. But political and geopolitical issues cannot be ignored forever.
We anticipate more rotation ahead, with Tech still looking the most vulnerable. Many Industrial DOW components look very stretched as well. We have been building our exposure to Financials who stand to benefit the most with a tax deal and looser regulations ahead. We see a lot of value within the Consumer sector, as many of these stocks have been battered this year and should experience strong demand into the holidays and the new year. But the big gap down today caught our attention. It’s a preview for things to come. December is normally the strongest month for stocks. Momentum could keep this rally going through the holidays. But then again, this year has been anything but normal.
There will be plenty more politicking over the weekend and nothing else is certain. 2017 has proven it.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
