Buckle Up

In the 1st Quarter of 2017 it will mark 8 years of the bull. Valuations are elevated to say the least but new policies from the White House and Republicans may give another boost to the market. A new resident at 1600 Pennsylvania Avenue can introduce risk to the market. A new leader in the Executive Office may prefer to take a recession or market rout early on in their term in order to blame the other guy. But this new leader seems to be unlike any other we have ever seen. In the short term moving into Q1 we think that there may be some buyer’s remorse on the Trump win. Not in relation to Trump (we are agnostic politically in terms of making investment returns) but in relation to getting those policies of decreased regulation, lower taxes and the repatriation of funds actually passed. The Supreme Court may have to come first.

January could find some bumps in the road but once a bull market gets this far we expect it to end in spectacular fashion. Two years come to mind that took place in a rising interest rate environment – 1981 and 1987. In 1981 Ronald Reagan came into the Oval Office with great expectations and saw stock prices up 5% in the first quarter of his Presidency.The market then fell over 19% in Reagan’s first nine months in office. While this does rhyme somewhat with the Trump Rally the landscape was very different in 1981. Although 1981 was a period of rising interest rates we saw a nation that was struggling with a 14 year bear market and an economy that was treading water with Fed Fund rates in the early teens and rising. 1981 was an environment of low valuations and high interest rates which is just the opposite of what we have today.

A year that might have more significance would be 1987. At the dawn of 1987 share prices had appreciated more than 100% from the lows put in 5 years earlier and the year began with a bang. The Dow Jones would be up 35% by August of that year. While the Federal Reserve was raising rates euphoria ran wild on Wall Street with seemingly daily mergers creating wealth for shareholders. “Animal Spirits” of a rising stock market took hold and shares ran higher with investors fearing that they were being left behind and easy money was being made on Wall Street. 2017 could bring something very similar. Investors are anxious as valuations are historically elevated and, while not wanting to take on added risk, there is a fear of being left behind. According to Sir John Templeton bull markets die in euphoria. We are at the point where we think this market is close to euphoria and it being more likely that this bull move ends with a bang and not with a whimper. While valuations have us cautious and protecting against negative shocks to the system what we could see is a shocking move higher.  

In Jeremy Grantham’s work on bubbles he postulated in June of last year that the market could run up to close to 3000 on the S&P 500 before breaking under the weight of excessive bubble – like valuations. That would be about 30% from here.

This week it became evident that Trump’s win could give rise to policies that would provide the Fed the cover that it needs to be more aggressive in raising rates. In their first post election meeting Janet Yellen and the Federal Reserve are predicted 3 interest rates hikes in 2017 rather than the 2 expected previously. While we all know the Fed is notoriously inept at predicting anything its current projections show a more aggressive hawkishness from its previous stance. This could help normalize interest rates into the range of 2-5% that the Fed prefers. This would be healthy from a longer term perspective and give the Federal Reserve ammunition should another crisis arise but it may produce some bumps in the road near term. We think that this normalization would be a net positive by giving business owners more confidence and more impetus to invest in their organizations which in the long term would be supportive to jobs and the economy.  

US Treasury rates on the 10 year are hovering around 2.6% as they seemingly stabilized this week. As far as equities go investors kept their wallet on their hip this week and did not drive the market into further overbought territory. There is some angst over the end of the year and the memory of the last several January’s which saw equities move lower. We expect investors are ready and willing to buy the next dip. That dip will probably not be pronounced and may provide kindling for the animal spirits to drive the market higher in 2017.   

Chinese may be struggling as they saw had debt and currency issues this week. Their currency is falling rapidly as they try to maintain control. China’s economy and their relationship with the US is shaping up to be THE story of 2017.The Saudi’s still wish to see a higher oil price at least until the Aramco IPO gets floated in 2017. They will try and keep oil stable and rising until then. Watch the Aramco IPO for clues as to oil’s direction. Markets are still overbought and Santa has not even arrived yet. Market pundits are seemingly all calling for a low return year. What you expect is not usually what you get when it comes to the stock market. When everyone is leaning one way we lean the other. We see volatility coming back and some wide swings up and down. Buckle up.   

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

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