This post is by David Merkel from The Aleph Blog
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I wish I could have found a picture of Woodstock with a sign that said “We’re #1!” Snoopy trails behind carrying a football, grinning and thinking “In this corner of the backyard.”
That’s how I feel regarding all of the attention that has been paid to the S&P being up every month in 2017, and every month for the last 14 months. These have never happened before.
There’s a first time for everything, but I feel that these records are more akin to the people who do work for the sports channels scaring up odd statistical facts about players, teams, games, etc. “Hey Bob, did you know that the Smoggers haven’t converted a 4th and 2 situation against the Robbers since 1998?”
Let me explain.
A month is around 21 trading days. There is some variation around that, but on average, years tend to have 252 trading days. 252 divided by 12 is 21. You would think in a year like 2017 that it must have spent the most time where 21-day periods had positive returns, as it did over each month.
Since 1950, 2017 would have come in fourth on that measure, behind 1954, 1958 and 1995. Thus in one sense it was an accident that 2017 had positive returns each month versus years that had more positive returns over every 21 day period.
How about streaks of days where the 21-day trialing total return never dropped below zero (since 1950)? By that measure, 2017 would have tied for tenth place with 2003, and beaten by the years 1958-9, 1995, 1961, 1971, 1964, 1980, 1972, 1965, and 1963. (Note: quite a reminder of how bullish the late 1950s, 1960s and early 1970s were. Go-go indeed.)
Let’s look at one more — total return over the whole year. Now 2017 ranks 23rd out of 68 years with a total return of 21.8%. That’s really good, don’t get me wrong, but it won’t deserve a mention in a book like “It Was a Very Good Year.” That’s more than double the normal return, which means you’ll have give returns back in the future.
So, how do I characterize 2017? I call it The Little Market that Could. Why? Few drawdowns, low implied volatility, and skepticism that gave way to uncritical belief. Just as we have lost touch with the idea that government deficits and debts matter, so we have lost touch with the idea that valuation matters.
When I talk to professionals (and some amateurs) about the valuation model that I use for the market, increasingly I get pushback, suggesting that we are in a new era, and that my model might have been good for an era prior to our present technological innovations. I simply respond by saying “The buying power has to come from somewhere. Our stock market does not do well when risk assets are valued at 40%+ of the share of assets, and there have been significant technological shifts over my analysis period beginning in 1945, many rivaling the internet.” (Every era idolizes its changes. It is always a “new era.” It is never a “new era.”)
If you are asking me about the short-term, I think the direction is up, but I am edgy about that. Forecast ten year returns are below 3.75%/year not adjusted for inflation. Just a guess on my part, but I think all of the people who are making money off of low volatility are feeding the calm in the short-run, while building up a whiplash in the intermediate term.
Time will tell. It usually does, given enough time. In the intermediate-term, it is tough to tell signal from noise. I am at my maximum cash for my equity strategy accounts — I think that is a prudent place to be amid the high valuations that we face today. Remember, once the surprise comes, and companies scramble to find financing, it is too late to make adjustments for market risk.