Those who grew up in the golden years of space exploration remember the thrilling sequence of the long countdown before a mission. In the great hall of the control center the launch director interrogates the system managers one after the other (engines, software, fuel, weather, astrodynamics and many others) and if he receives the green light (go) from all, he addresses the mission director declaring All systems go and expecting from him the fateful Go for launch.
If we imagine something similar in the hypothetical control room of global financial markets we have today such a sequence.
– America's economy subsystem?
– Growth above three percent. go.
– Europe economy subsystem?
– Growth close to three per cent. go.
– Asia economy subsystem?
– Five percent growth. go.
– Emerging economy subsystem?
– Growth above three percent. go.
– Ok, the economy system is go.
– Inflation system?
– Below 2 percent but close to 2 percent in all advanced subsystems, including the US PCE. At 5 per cent in emerging subsystems, stable and within the planned tolerance limits. Slowly increasing dispersion between indicators, but stable median. Inflation is go.
– Thank you inflation. Liquidity system?
– Global monetary base decelerating as planned but still increasing by the last trillion in 2018. Possible further modest deceleration in Europe and Japan, but within tolerance limits. Liquidity is go.
- Optimal. Rate system?
– Negative short-term real rates in all subsystems. Long-term real rates are strongly negative in Japan, negative in Europe and moderately positive in China and America. Possible critical issues on long-term rates in America and Germany, but at present everything is within tolerance limits. Rates is go.
– Good rates. System change?
– Controlled depreciation of the dollar in the parameters and absorbable by the rest of the world. Change is go.
– Thank you change. System useful?
– Expected growth of 15 percent in Asia and America, close to 10 in Europe. Modest downside in the event of wage inflation above forecasts. Likely decrease in buybacks offset by increase in dividends. Useful is go.
– Evaluations & flows?
– Evaluations are within the limits of tolerance, even if in the upper part of the range. Flows to equities showing a lively recovery but historically in the norm. Ratings & Flows is go.
- OK, perfect. geopolitical system?
– Nuclearized North Korea now accepted. Iran and Saudi Arabia absorbed by internal problems. Nafta under review but not in danger. Geopolitics is go.
– Thank you geopolitics. All systems are go. The launch is go.
We have already seen that the launch is go at the beginning of the year. One twentieth of 2018 has passed and the SP 500 has already grown by 4.82 percent. Continuing like this, 2018 would see an appreciation of 96 percent or, compounded, 156 percent. As you can see, there is some routing problem. If the stock market rises by 96 and profits, in America, by 14, it means that the multiple rises from 18 to 35. This is reasonable in a context of a mature cycle, of rising rates and with half of the increase in profits due to a lower tax rate that the next Congress can cancel when it wants? No, that's not reasonable. In a phase like this, it is right to start from the hypothesis of a stable multiple, if not in slight contraction.
Basically, looking at the consensus estimates of the houses, in one twentieth of 2018 we have already played half of the potential upside for the whole year. And if that's true, what do we do for the remaining nineteen-twenties of the year? Are we growing by 0.5 a month? Or 0.02 per session? Certain, bond traders would sell their souls to get 0.02 a day (with a Japanese 2018-year it takes three months to bring home such a yield) but for those on the stock market this can only mean two things, alternatively. The first is that 2017 is an even more boring year than XNUMX. Possible, but very unlikely.
The second is that it rises by inertia for some time to come thanks to the flows of those who are only now in touch with the share price increase that began in 2009 and then correct. Besides, a curious fact occurs. Managers and strategists parade on CNBC or Bloomberg TV every day and 1) declare themselves very optimistic about the possibility of reaching 2850-2900 this year and 2) say they are certain that there will be corrections towards 2500-2600. Today, at 2800, we are much closer to the upper than the lower limit. If we were cold machines, faced with these numbers, we would sell right now (naturally to buy again later).
Since we are human, and therefore extrapolative, we are instead inclined to hold and, perhaps, to buy again. It feels too good and sweet to be carried away by the upside, especially when it's not interspersed with annoying corrections. What do we want to say? That in a year that is overall still positive but more volatile, we need to look inside and make a decision. Either you focus on December 31, 2018 and serenely decide to remain substantially still throughout the year or you gear up for a volatile year. Equipping means in turn two things.
The first is to declare oneself willing to increase the share of equities on the downside (easy to say, ex ante, more difficult to do if the correction is caused, as likely, by a fear of interest rates or growth). The second, alternatively, is to create liquidity now (or at least in the first months of this year) to be able to reinvest it at more convenient levels. All are reasonable alternatives. The important thing is to have awareness and adopt a strategy.
