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Higher Highs Can Mean Larger Losses

As we near the end of 2017, we want to reflect on what has been a very good year for the market and the U.S. economy. Some would say a near perfect year. Consider the following facts:

  • 2017 will be the 9th straight year of gains for US equities (which ties an all-time record)

  • The Dow has closed at an all-time high 66 times in 2017 (Highest # since 1995)

  • The S&P 500 is now up 13 months in a row (longest run since 1928)

  • US jobs, as measured by Non-Farm Payrolls, have now reached 86 months of consecutive growth (by far the longest streak in history)

  • The U.S. Unemployment rate is at a 16 year low.

  • Consumer confidence is at a 17 year high.

  • Inflation remains low with core CPI below 2%.

  • Earnings of US companies are at a record high and profit margins are near their highest levels in history.

  • Volatility has been extremely muted with rolling 12 month volatility measurements in U.S. stock and bond markets near all-time lows.

How long can this last? Who knows? But, all of these things are really good for now and we are thankful for them in 2017. The problem is that this is usually around the point in most stock market cycles where investors become complacent or maybe even a bit greedy. Everything is great, right? Yes, for now. But what you might miss is that higher highs often lead to larger losses. Consider the following facts:

  • US stock markets have now reached the highest P/E (Price to Earnings) valuations since the tech boom / dot com era of 1999-2000.

  • Drivers for earnings growth in the U.S. are no longer consistent with investors’ current appetite to pay premiums for U.S. stocks.

  • Sectors that would benefit from proposed tax reform have already increased by around 20% since August 2017 (source: JP Morgan 12/11/17). What happens to stock prices after the law passes, or doesn't pass?

  • Many economists rank the U.S. market as the most expensive stock market in the world. (StarCapital Research, etc.)

We have no idea when many of the current positive market trends will end, but we do know these kind of conditions were observed prior to past market corrections. With that in mind, we are taking this opportunity to take profits with a few minor rebalancing trades in discretionary client portfolios as we near the end of 2017.

  • We continue to employ our AFP Defined Risk Strategy in which we will remain invested in equity markets as long as current trends remain intact, but we stand ready to reduce equity exposure when markets drop below key technical levels. We feel that it is crucial to have a strategy in place to protect recent market gains in this environment.

  • We are slightly reducing exposure to some U.S. stock positions in favor of International equities which have more attractive current valuations, higher dividends, and better growth forecasts.

  • We are reducing credit sensitive fixed income positions and re-allocating those assets to more diversified fixed income holdings.

Bottom Line: We are very pleased that 2017 has been a great year. We remain cautiously optimistic on the market going forward. But we do want to directly warn you that all good things must come to an end. We hope it is way down the road but we stand ready for the end of this market cycle, whenever that may be…

Best Regards, Lyn

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