JULY 2017 A feature article from our U.S. partners
Will the Markets’ Fairy Tale Year Have a Happy Ending?
2017 has been a Goldilocks year so far, with stocks and bonds up amid record-low volatility. But 2018 could be a different story.
by Jurrien Timmer, Director of Global Macro, @TimmerFidelity, Fidelity Investments
• Investors have enjoyed the best of both worlds this year, with stocks and bonds rallying together amid record-low volatility.
• Non-U.S. equities (led by Europe) have outperformed domestic stocks so far, which may be part of a larger mean reversion.
• One looming concern is a disconnect on monetary policy, with the Fed penciling in seven more rate hikes in the next two years versus the market’s expectation for one or two.
• The aftermath of China’s massive reflation is another critical piece of the puzzle, given its role in fueling the global business cycle.
• The FANG trade (an acronym representing four popular technology stocks) has received a lot of attention lately, prompting comparisons to the 2000 tech bubble; however, the fundamentals
The year so far
At the beginning of each year when strategists produce their annual outlooks, the consensus is often wrong. For example, following the U.S. election seven months ago, the overwhelming consensus was for a fiscal-policy.induced pickup in consumer confidence, accompanied by policy-induced volatility. Coming so late in the cycle, the fiscal boost was expected to create an environment for higher inflation, higher interest rates, and a stronger
U.S. dollar. The thinking was also that the more policy- sensitive small-cap stocks would outperform large-caps. All of this may well still happen, if and when we do get fiscal policy changes. But very little has happened on the policy front so far and expectations are low for anything substantive anytime soon. As a result, the JP Morgan Trade Weighted U.S. Dollar Index is down 5% year to date (YTD),1 the 10-year Treasury yield is down to 2.15%, and the small-cap Russell 2000® Index is trailing larger-cap benchmarks. Meanwhile, inflation has been all but missing in action, with the core PCE rate2 (the Federal Reserve’s favorite inflation barometer) falling to 1.5% year over year. for tech stocks are anything but dangerous.
This has resulted in a sharp and unexpected de-rating of inflation expectations. Amid this unwinding of the “Trump trade,” there has been a significant rotation out of small-caps, financials, and value stocks and into the technology sector, especially the FANG stocks (an acronym representing four popular technology stocks). This has caused some people to make comparisons to the tech bubble in 2000. But these concerns seem misplaced. While tech prices have soared (until some air was let out a few weeks ago), the sector today comprises about 21% of the stock market’s capitalization,3 whereas in March 2000 it was roughly 35%. Also, the trailing price-to-earnings (P/E) ratio for tech is currently only 20x. In 2000, its P/E reached 71x!4
I think of market leadership not so much in terms of the 11 market sectors, but more in terms of three themes or regimes: cyclical growth (financials, industrials, energy, small-caps), secular growth (stocks that grow strongly regardless of the business cycle), and income-oriented (the so-called “bond proxies,” or stocks that take their cues from bond yields). Each of these buckets has led the market at some point in recent years, and I think the rotation from one to the other is healthy and normal. I for one am not concerned about a perceived “FANG bubble,” especially now that their advance has paused.