It's important to realize that the levers moving the markets have shifted in 2018. It's a concept I have been discussing since early in the year. Not paying attention to the shift is going to trap many investors in a vicious cycle of disappointment.
Up to this point, since early 2017, the markets have been moving on a positive expectation for earnings improvements brought about by a rising economic tide, supported by ultra-aggressive fiscal policy and the residual effects of historic monetary stimulus. As long as earnings supported price, stocks would rally. To date, everything has been peachy and straightforward.
That peachy economic environment is not going to change. Earnings will continue to come in at or better than expectations against a backdrop of a booming economy. However, the influence of earnings has now shifted from being an overwhelming positive force to a much more divisive factor. In other words, while the economy will remain peachy, the straightforward nature of things has come to an end.
Interest rates are changing everything across the entire risk asset spectrum. The markets are beginning to realize that a generational shift in interest rates is occurring that is going to suddenly make risk free assets compete for investor dollars. At the same time, the corporate debt binge that has fueled our current growth is now substantially more expensive for the corporations that depend on that fuel to prosper.
The equilibrium that has created prosperity in the asset markets has shifted. Investors are no longer concerned with the purity of earnings growth, instead turning their attention to the fact that perhaps stronger earnings growth equates to higher interest rates, which ultimately equates to greater uncertainty.
Equity markets find themselves in a complicated spot that they haven't been in at anytime during the current secular bull market that has been set on a foundation of easy money and relatively straightforward analysis.
The upcoming earnings season is going to be an exercise in this new reality. Investors who believe that simple positive earnings reports from a group of the most popular investor names will propel the markets to new highs are going to be continually disappointed. A set of new levers is in the process of being created that will cause new correlations to take place among an entirely new set of assets that will then allow the bull market to progress.
Adjust accordingly, as the next two years will look nothing like the last two.
