01/09/2018
What a way to start the new year! After meandering sideways for a couple of weeks at the close of 2017, as investors digested the impact of tax reform and in the face of year-end repositioning, stocks came roaring out of the gate in the first week of trading in the new year. The S&P 500 rose 2.6 percent in the holiday- shortened week, its best performance in over a year. The results were clearly a vote of confidence in the economy, as no fewer than five sectors gained more than 3 percent, led by energy, materials and technology, but also including consumer discretionary and healthcare. The laggards were utilities and REITs, both falling more than 2 percent.

Contributing to the strength in equities was the softer dollar, which extended its trend from last year by drifting modestly lower. Also notable last week was the steep drop in volatility. The VIX index had edged higher into last year’s close, rising from 9.4 in mid-December to end the year at 11.0, both admittedly quite low levels themselves. But, as trading began last week, the index immediately began retreating down to 9.2 as if a switch had been thrown, closing just fractionally above its November record low.

A Solid U.S. Economy and Strong Earnings Reinforce a Sense of Optimism

Last week’s economic reports reinforced the general sense of optimism. Driven by the strongest reading for new orders in fourteen years, the ISM manufacturing index rebounded more than expected in December, following declines in the previous two months. And although the December jobs report was viewed as a modest disappointment, as the 148,000 new non-farm jobs fell short of the 190,000 that were expected, it was more than enough to maintain the jobless rate at 4.1 percent and consistent with the expectation that job growth at this stage will inevitably be slow.

Perhaps the biggest contributor to the surge in sentiment is the rising sense of optimism regarding earnings. Factset now calculates expected bottom-up earnings growth in 2018 at 13.1 percent, up from 11.1 percent at the start of the fourth quarter, with the increase driven by a rise in upward revisions since the middle of December following the passage of tax reform. Not to be overlooked, fourth quarter earnings season gets underway this week, with the major banks getting things started, including JP Morgan and Wells Fargo. In addition to a daunting double digit anticipated gain for the quarter, management guidance will be especially important this time around as companies have had time to digest the implications of the new tax legislation.

Stock Market Euphoria Felt Around the World

Last week’s strength was by no means just a U.S. phenomenon. Stock markets around the globe were even stronger than at home. In the Eurozone, where manufacturing and producer prices were strong, the Eurostoxx 50 index climbed 3.2 percent in dollar terms. In Japan, the Nikkei index rose 3.6 percent in dollars. The MSCI Asia index climbed 3.7 percent and the Latin America index surged 5.0 percent.

Bond yields in the U.S. edged higher last week, retracing some of the declines experienced prior to year-end. The yield on the ten-year note rose 7 basis points to 2.48 percent, leaving it just shy of its nine-month high of 2.50 percent on Dec. 20. The two-year ended the week at 1.96 percent, higher by 8 basis points on the week, and at its highest level since October, 2008. Both maturities rose modestly following the release of the Fed’s meeting minutes on Wednesday, although the move was relatively muted. The cumulative effect was a fractional flattening of the yield curve on the week. The real story in bonds last week was in below-investment grade credit spreads. Mirroring the strength in equities, the option adjusted spread between the Bank of America Merrill Lynch High Yield Master II index and the ten-year note plunged 22 basis points to 336, the tightest spread since June, 2014.

Amidst all the euphoria it is worth noting that, by some measures, market sentiment is becoming excessively optimistic. The Investor Intelligence Investment Advisor’s sentiment index currently indicates that 69 percent are bullish, whereas 45 percent is considered the norm. And the American Association of Individual Investors sentiment survey shows 60 percent of respondents are bullish, the highest level in seven years. The long-term average bullish ratio is 38.5 percent. Contrarians take note.

Important Disclosures:
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances.
Past performance is not a guarantee of future results.
S&P 500 Index: Is an unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a widely used measure of market risk. It shows the market's expectation of 30-day volatility. The VIX is constructed using the implied volatilities of a wide range of S&P 500 index options.
The ISM manufacturing index is a national manufacturing index based on a survey of purchasing executives at roughly 300 industrial companies.
The EURO STOXX 50 is a market capitalization-weighted stock index of 50 large, blue-chip European companies operating within eurozone nations. The universe for selection is found within the 18 Dow Jones EURO STOXX Supersector indexes, from which members are ranked by size and placed on a selection list.
The Nikkei index is a price-weighted average of 225 stocks of the first section of the Tokyo Stock Exchange.
The MSCI Emerging Markets Asia Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. It consists of the following emerging market country indices: China, India, Indonesia, Korea, Malaysia, Philippines, Taiwan, Thailand.
The MSCI EM (Emerging Markets) Latin America Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of emerging markets in Latin America. The MSCI EM Latin America Index consists of the following 5 emerging market country indices: Brazil, Chile, Colombia, Mexico, and Peru*.
The Bank of America Merrill Lynch High-Yield Bond Master II Index is an unmanaged index that tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.
The Investor Intelligence Investment Advisor’s sentiment index surveys the market views of over 100 independent investment newsletters (those not affiliated with brokerage houses or mutual funds) and reports the findings as the percentage of advisors that are bullish, those bearish and those that expect a correction.
The American Association of Individual Investors Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market short term; individuals are polled from the AAII Web site on a weekly basis. 
Indexes are unmanaged and are not available for direct investment.
The information and opinions in this article are compiled from third party sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Ameriprise Financial. The information is not intended to be used as the sole basis for investment decisions, nor should it be construed as advice designed to meet the particular needs of an individual investor.
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