"Blast-off" or "As good as it gets"

2017 has been a rocket ship type of year, from Bitcoin to FAANG to High Yield, to EM FX, pretty much everything has done well. Even the Deflationists have had a decent year as long they weren't in the front end. The question for 2018 though is can we expect it to continue

To be fair, your author was writing a similar post early in 2017 arguing that this was probably close the the top in economic growth as proxied by the ISM. Clearly I was wrong, so take the rest of this post for what is worth. 

1) Spreads. Take a look at HY and BBB spreads. 

While not outright bearish as there is room for more compression, we are clearly near the expensive part of the range. And of course it makes sense, corporate profits are killing it. But under the hood, a lot of CCC and B bonds are not doing well. Retail, telecom and parts of health care are all under performing. 

I took all the issuers in the HYG and split them up by ratings, and made an equally weighted equity portfolio for each. You can see HYG - B issuer's stock prices have been ugly. Not a good sign for the bonds going forward. While bond guys might be the smartest, individual names are usually best left to the equity jocks, IMO, until they get to distressed levels. 

Whereas the BB issuers have doing a quite a bit better and trading more or less in line with HYG  but under-performing the Russell 2000 (though there are some different sector weightings so not sure Russell is the best benchmark)

Flag number # 2, corporate earnings have been rising due to synchronized global growth. And while the multiple has expanded, when you have rising earnings, its the fuel to the equity rally. This is an earnings driven market IMO. Figure out where earnings are going, first, and then prices follow

You can see the 2017 synchronous global growth story show up a lot of measures, including economic surprises, global PMI, commodity prices, EM FX, earnings revisions and others. But we are pretty much at peak levels for most

For me, the elephant in the room is China. We know they are slowing heavy fixed asset investment and trying to reign in the housing market in Tier 1 and 2 cities. Supply side reforms are for real and they are having the intended effect of boosting corporate profits. In addition, a tight labor market with wage increases is helping consumer spending and the dynamic transition towards internet businesses. Clearly BABA, Tencent, JD, Weibo and others are doing something right and the Chinese consumer is healthy. But its the industrial and manufacturing sectors that are the cyclical ones to watch, in particular exports. And for 2018, I'm sticking with my guns and assuming China slows down, particularly after Q1. 

Where I could be wrong is if global growth keeps on chugging along at high levels which spurs capital spending. While the US tax reform is a good reason for companies to open up the check book, I'll wait to see the evidence. But it is possible we see a pickup in global capital spending, particularly since its been so depressed in areas like the EU for the past several years. Consumer and CEO confidence is high, so this is something to watch.

Happy Holidays