A strong start to the new year?
January 11, 2017
Shashi Mehrotra is the Chief Operating Officer and Chief Investment Officer of Legend Advisory and a pioneer in the application of artificial intelligence to the field of investment management.
He is the chief designer of Legend's Asset Allocation Neural Network (AANN). AANN is a sophisticated computer model that uses mathematical algorithms to forecast the relative strengths of different asset classes. Mr. Mehrotra spent over a decade on the research, development, testing and implementation of AANN's state-of-the-art artificial intelligence system.
4th Quarter 2016 Market Commentary
For 2017, I am optimistic about the first half of the year but foresee a volatile second half. All of the market indicators I am seeing point to a strong start to the new year because I believe we’re in a secular bull market for equities. A secular bull is a period of many years, usually 15 or more, where assets are rising in value. Some say secular bulls in equities cannot happen when interest rates are going up, but that’s not necessarily true. Yes, the secular bull between 1982 and 2000 was primarily fed by bond yields falling down. However, we had another secular bull between 1942 and 1966 during which the bond yields were rising. It wasn’t as strong as the other one but we still had an 11% average annual return during that time. (1)
The current secular bull started in March 2009 and I believe we have at least three to five more years to go. During a secular bull there are still going to be short periods of downturns (cyclical bears) but they usually don’t derail a secular bull. The market could experience a 10-15% correction after the first quarter of 2017. I see this as an opportunity rather than something to be overly concerned about. We could also see volatility during the second half of the year based on the historical patterns I have observed. Additionally, earnings still need to rise because we’re a little high on the valuations. The rise in oil prices placates my concerns a little bit. Oil prices are up to $52 a barrel, 99% up from the $26.21 low in February of this year. (2) I think there’s more room to go for oil prices and that would give a nice boost to earnings in the energy sector and thereby the S&P 500 Index. And if that happens, valuations may be less of a concern. If the price keeps going up and earnings don’t, then the overall number (Price/Earnings) keeps expanding. The other thing that could make earnings go up is corporate tax rate cuts, which President-elect Trump is talking about doing.
The economy is in its eighth year of slow expansion. This has been the slowest recovery since the great depression. (3,4) Since 2008-2009, the economy has been going up continuously but at a snail’s pace. But this lack of speed is the reason that it’s been able to go on for so long. That’s why I see the slow pace as a blessing in disguise. To me this is really the best-case scenario. If growth came too fast, inflation could rear its ugly head. This is the right combination of pace of economic growth that the market continues to relish.
While I’m bullish on domestic equity markets, I do believe there will be a point where the favorable prospects are going to move on to other parts of the globe. This shift to foreign markets hasn’t happened as I have been anticipating. Domestic markets have continued to outperform everything else. If emerging markets outpace everything else next year, I think that’s a change that could have a huge impact on investors’ portfolios if they aren’t positioned appropriately.
An area I’m not concerned about is the Federal Reserve (the Fed) raising interest rates. Some analysts argue that the Fed raising interest rates could cause a negative impact on the market. There is an old adage "three steps and a stumble" which means if they raise interest rates three times, the markets begin to falter. That does tend to happen. However, if there is a long gap between rate hikes, the negative market impact is typically muted. (5) I also suspect that the Fed is not going to be as fast at raising interest rates as some investors anticipate. I think they’re going to wait six months before they touch it again. And if unemployment falls enough and inflation’s not kicking up then they may leave interest rates alone.
(1) Ned Davis Research
(3) U.S. Bureau of Economic Analysis, “Table 1.1.6. Real Gross Domestic Product, Chained Dollars,” (accessed December 27, 2016).
(4) National Bureau of Economic Research, “US Business Cycle Expansions and Contractions,” (accessed December 27, 2016).
(5) Dudack Research
Shashi Mehrotra, Chartered Financial Analyst, is the Chief Investment Officer of Legend Advisory Corporation. The opinions and predictions expressed herein are those of Shashi Mehrotra solely and not necessarily the opinions or expectations of Legend Advisory Corporation or any of its affiliates. Such opinions and predictions are as of December 20, 2016, and are subject to change at any time based on market and other conditions. No predictions or forecasts can be guaranteed.
Current market and economic data is as-of December 20, 2016. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.
This material does not constitute a recommendation to buy or sell any specific security. Past performance is not indicative of future results. Investing involves risk, including the possible loss of a principal investment.
Investment in equities involves more risk than other securities and may have the potential for higher returns and greater losses. International investing involves risks not associated with U.S. investments. International investing involves additional risks, including the potential for limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks may be magnified in emerging markets. Bonds have interest rate risk and credit risk. As interest rates rise, existing bond prices fall and can cause the value of an investment to decline. Changes in interest rates generally have a greater effect on bonds with longer maturities than on those with shorter maturities. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and/or interest payments.