Market sentiment, as measured by the Investor Intelligence survey, is extremely bullish, and has been for months. The spread among market letter writers is as wide as it gets. Bulls are 62%. Bears are 15%. This is a dangerously wide difference. It makes you wonder who is left to buy stocks.
At the same time, the technology sector is up over 30% year to date. The entire Standard and Poor’s 500 has returned some 18%. If you took tech out of the S&P, the return would be close to 13%. Earnings have been great for the tech sector stocks, and generally for all sectors except energy. So, it is not surprising that tech has outperformed. But, the stocks are extremely extended. The large capitalization growth ETF which is dominated by the tech stocks, is some 20% above its 200 day moving average. These are extremely overbought conditions. The tech sector could have a 15% decline and its bull market would be intact. Some correction is highly likely.
Meanwhile, value stocks have done OK, but not nearly as well as growth. Large and midcap value indices are up just under 10% year to date. That is a good return. But this year has seen such a large disparity of returns that a combination of a catch up move in value, and a pullback in growth would seem highly probable. Otherwise one of the core principals of investing, mean reversion, has to be thrown out the window. And, if that goes, efficient market theory would have to go too. It won’t happen.
Timing, of course is everything. November 29, the Dow Jones Industrial Average was up about 0.5%. The NASDAQ was down 1%, led by the big tech stocks. My guess is that this is the beginning of the correction within the market. Economic growth, both here and around the world is accelerating. Basic industries, manufacturers, financials, etc. will be showing earnings growth that is accelerating as well. For a time, these companies could have growth that challenges the growth of the big tech stocks. Banks, distributors, even retail will show improving earnings and will likely have a relative return catch up next year. Even energy could have a bounce once tax loss selling is done. So, within the market, a correction in favor of value is in order.
As for the overall market, it is extended. But a correction of 5-7% would not put a dent in the Bull market trend. I would expect something like that beginning in mid-January through February. The big tech stocks could correct twice that much.
The Bull Market, though would remain intact. Stocks in 2018 will have more volatility and should have a positive return for the year. But, returns will fall well short of this year’s results.
Robert C Davis is a Chartered Financial Analyst and is affiliated with Woodlands Asset Management, Inc. as a consultant. Founding partner of Davis Hamilton Jackson and Associates, a Houston based investment advisory firm; Bob is now retired and living in Chappell Hill, Texas. He now lends his expertise and knowledge of the markets to our company and customers. We hope you find it interesting and insightful.