2018 Yearly
Forecast
Random Predictions For 2018
1) In 2017 the US stock market's lack of volatility was record breaking.
As noted last week, this is evidenced by the SPX's average daily change in
2017 being the smallest since 1964, the absence during 2017 of a single
trading day with an SPX gain of more than 1.4%, and the fact that the SPX
is immersed in its longest stretch ever (14 months and counting) without a
peak-to-trough decline of more than 3%.
In the financial markets, extremes in one direction are often followed by
extremes in the opposite direction. Also, a lot of computer-generated
trading is predicated on the continuation of the low-volatility
environment. This creates the potential for an increase in volatility to
become self-reinforcing at some point, with rising volatility leading to
the automatic selling of stocks, resulting in a further rise in
volatility, and so on.
Therefore, the US stock market is set to experience greater-than-average
volatility this year.
2) When attempting to predict when a period of economic growth will end it
is futile to look more than 6 months into the future, because there are no
leading recession indicators that can predict that far ahead with
acceptable reliability. There are, however, leading indicators that can be
used to determine the probability of a recession beginning within the next
several months. The current situations of these indicators result in the
following prediction:
The US economy will not commence an official recession during the first
half of this year.
3) It is yet to be confirmed by the price action, but it's a good bet that
the Bitcoin bubble reached its maximum level of inflation late last year.
Also, the broader bubble in cryptoassets is set to burst during the first
quarter of this year.
We doubt that there will be a specific catalyst for the bursting of the
bubble, just a spreading realisation that these digital tokens have
unlimited supply, no sustainable value and no chance of ever garnering
widespread use as media of exchange.
By the end of 2018 it will be apparent that the public's enthusiasm for
Bitcoin and the "alt-coins" was one of history's great speculative manias.
4) Despite spectacular collapses in the prices of the popular
'cryptoassets' during 2018, central banks including the Fed and the ECB
will firm-up plans to introduce their own blockchain-based currencies.
This will be driven by a desire to eliminate physical cash, the thinking
being that if there is no physical money it will be more difficult for the
average person to make/receive unreported payments and escape a negative
interest rate.
5) Due to rising commodity prices it's a good bet that "price inflation"
will become a higher-profile issue during the first half of 2018,
prompting the Fed to move ahead with its quantitative tightening (QT) and
make two more rate hikes. However, both the QT and the rate-hiking will be
put on hold during the second half of the year in reaction to increasing
downside volatility in the stock market.
The US Stock Market
Our 2017 forecast for the US stock market was vague, but in one respect it
couldn't have been more wrong. We were correct to write at around this
time last year that the sort of collapse that occurred in 2008 was not a
realistic possibility for the year ahead and that the bull market probably
wouldn't end during the first half of 2017, but we were completely wrong
when we wrote: "The
market's performance during the year will be characterised by the word
"volatility", with multiple declines of at least 8% followed by quick
recoveries."
As it turned out, the US stock market's performance during 2017 was
characterised by the phrase "lack of volatility". For the first time ever
there wasn't a single correction of more than 3%. Furthermore, the VIX was
below 10 on 52 trading days during 2017 after spending only a few days
below 10 during the preceding three decades.
A 2018 forecast that has almost no chance of being wrong is therefore: the
US stock market will be more volatile in 2018 than it was in 2017.
Actually, we expect that 2018 will go part of the way to counter-balancing
2017 by being more volatile than average, at least when volatility is
measured in terms of the average daily SPX change and the number of 5%+
SPX declines.
The biggest difference between the situation now and the situation near
the start of each of the past few years is that the monetary backdrop is
no longer supportive. In fact, it has become a slight head-wind and will
become a strong head-wind by the third quarter if the Fed and the ECB
stick to their current plans.
That being said, the monetary backdrop only turned negative about three
months ago and it can take 6-12 months for the effects of such a shift to
become apparent in the financial markets and the economy. Also, there is
not yet any evidence in the yield curve or credit spreads that the
tightening of monetary conditions has become critical. We therefore expect
that the stock market will work its way upward during the first half of
2018, although we also expect that the advance will be 'choppy' and
include a Q1 correction of 5%-10%.
At some point during the second half of 2018 the tightening of monetary
conditions should become critical, with a 15%-25% SPX decline being one of
the most obvious consequences. Whether or not this decline marks an end to
the bull market will depend on the central-bank reaction at the time, in
that a rapid policy shift from monetary tightening to loosening could
extend the long-term advance.
We expect that commodity-related stocks will be among the best performers
during the first half of the year, but that all sectors of the stock
market will suffer large declines during the second half with the possible
exception of the gold-mining sector.
The gold-mining sector can benefit from weakness in the broad stock
market, but only if it is not 'overbought' at the time that a period of
extreme broad-market weakness begins. For example, the gold-mining sector
benefited in a big way from the stock market weakness of 2001-2002 because
it entered the period at a low ebb, but it was hammered along with the
broad market in 2008 and 1987 because it was stretched to the upside when
large broad-market declines got underway. In other words, if the
gold-mining sector were to trend upward with commodity stocks and the
broad market during the first half of this year then it would be acutely
vulnerable to substantial broad-market weakness during the year's second
half.
Declining bond prices, a.k.a. rising interest rates, is the biggest
short-term threat to the equity bull market. To help explain why, here is
a chart that we have used in the past. The chart compares the SPX with the
price of the 30-year T-Bond during 1986-1987.
In 1987 the downward trend in the T-Bond price (rising interest rates)
didn't matter to the stock market until August, when the T-Bond broke
below an important support level. After that, the T-Bond's trend was all
that mattered to the stock market.
We suspect that the T-Bond's March-2017 low of 146, which is only three
points below the current price, is equivalent to the support level that
was breached in August-1987. If the T-Bond breaks below this support
within the next two months then the large stock market decline that we
presently envisage for H2-2018 may occur in H1.
The
Currency Market
The expectations we had for the currency market at the start of last year
turned out to be wide of the mark. We expected the Dollar Index (DX) to
begin the year will a decline lasting up to three months and to then rise
to a major high during either the second or the third quarter. The year
kicked off as envisaged, but rather than being a downward correction
within a bull market the Q1-2017 decline proved to be the first leg of a
bear market.
This year has started with speculators extremely bearish on the US$
relative to the euro (the DX is dominated by the US$/euro exchange rate).
It has also started with a downside breakout in the DX (a break below the
September-2017 low). The fact that the breakout wasn't quickly negated
suggests that it was genuine and will be followed by additional weakness
in the DX over the months ahead, despite the sentiment situation. The
sentiment extreme in the currency market, like the sentiment extreme in
the US stock market, warns of a significant first-quarter correction but
not a major reversal.
According to our currency fundamentals model the fundamental backdrop is
finely balanced at the moment. Our model is currently DX-bullish, but both
the interest-rate and the relative-equity-strength inputs are very close
to their moving-average demarcation levels. This means that a small change
could flip the model to US$-bearish.
Despite the continuation of the Fed's rate-hiking campaign in H1-2018 and
the ECB still being at least a year away from making its first rate hike,
interest-rate differentials at the long end could move in the euro's
favour during the first half of 2018 just as they did during the first
half of last year. This is mainly because European bond yields are
starting at much lower levels than the equivalent US bond yields. For
example, the US 10-year T-Note yield ended last week at 2.64% whereas
Germany's 10-year government bond ended the week with a yield of only
0.57%.
In summary, we expect the DX's downward trend to persist through the bulk
of this year's first half. If this happens then the anti-US$ sentiment
will be even more extreme, setting the stage for the DX to become very
strong during the year's second half.
Taking a broader view of the currency market, our expectation that
commodity prices will trend upward during H1-2018 combined with the A$'s
bullish COT situation leads to a forecast that the A$ and the C$ will be
the strongest major currencies during the first half of this year. Due to
its bullish COT situation the Swiss Franc is also poised to be relatively
strong during the first half of this year.
During the second half of the year, substantial declines in the commodity
and equity markets will, we think, lead to the A$ and the C$ being among
the weakest major currencies and the Yen being the strongest.
T-Bonds
Here's
how we summarised our annual T-Bond forecast at this time last year:
"We
expect that it will be another losing year for the T-Bond due primarily to
rising fear of inflation during the second half of the year, but that a
major T-Bond decline won't happen. Preventing a major decline will be
price-support from central banks and periodic flights to safety, with the
flights to safety being caused by stock market volatility in the US and
political drama in Europe.
The current price for the T-Bond is
151. We expect the price to trade near 140 before year-end, but not below
130. This expectation is based on the strong tendency for
intermediate-term declines in the T-Bond to bottom at or slightly below
the 84-month moving average...".
This forecast proved to be too bearish. 2017 turned out to be a flat year
for the T-Bond as what we interpret as a long-term topping pattern
continued to develop. The long-term topping pattern is evident on the
following monthly chart.
The above chart shows that the T-Bond has major support at 146 defined by
its lows of the past three years and its 84-month MA. A monthly close
below this support would confirm that the multi-decade bond bull market
had ended.
We expect that the aforementioned major support will hold if tested during
the first quarter but will be breached during the second quarter in
response to rising fear of "inflation".
In the second half of the year we expect to encounter substantial 2-way
bond-market volatility, with a strong 2-3 month rally at some point in
reaction to falling equity and commodity prices.
Overall, we are anticipating a down year for the T-Bond (an up year for
long-term interest rates), but not a large decline. We expect that major
weakness in 'risk free' government bonds will be one of the next decade's
big stories.
Gold
and the Gold Mining Sector
Mostly as a consequence of the US$ performing much worse than we expected,
the US$ gold price performed much better during 2017 than we expected it
would at the start of the year. Gold-mining stocks (as represented by the
HUI), on the other hand, performed almost exactly as expected in US$
terms*, but worse than expected relative to gold bullion.
For 2018 our gold-related expectations are linked to our expectations for
the US stock and bond markets.
For the first half of the year the key is the expected rising trend in
long-term bond yields. This should cause gold to underperform many other
commodities including the industrial metals, but with regard to
performance in US$ terms we have been anticipating, and continue to
anticipate, a sentiment-driven rise to test the 2016 high of $1377.
We mentioned in each of the past three Weekly Updates that the rise to
test the 2016 high could happen as soon as February. If so, the bulk of
this year's upside could occur during the first two months of the year.
However, even if the gold price rises to the US$1370s as soon as February
it should make a new high for the year during the second quarter in
response to US$ weakness.
In summary, we expect that during the first half of the year gold will
make a significant gain in US$ terms while losing ground relative to
commodities in general.
There's no point discussing in detail what gold is likely to do during the
second half of the year because the second half's performance will depend
to a large extent on what happens during the first half. Suffice to say at
this time that if the first half pans out roughly as expected then gold
could be boosted during the second half in both nominal dollar terms and
real terms by serious stock market weakness and a strong rebound in the
T-Bond.
That's gold bullion, but what about gold mining stocks?
We expect the gold-mining sector to do in the first half of 2018 what it
failed to do in 2017: provide leverage to an increase in the gold price.
However, if the aforementioned first-half performance is achieved then the
gold-mining sector will be acutely vulnerable to the downward pull that
potentially will be exerted by a large stock market decline during the
second half of the year.
Taking a wider-angle view, the set-up for a gold bull market is not yet in
place (it isn't possible for gold to be in a bull market while a
stock-market mania is in full swing). Instead, it looks like we are
dealing with a 2-3 year rebound along the lines of what happened in
1985-1987.
*We
predicted a Q1 rally followed by a trendless remainder of the year with
the HUI ending the year at 200 +/-10%.
Commodities
Our 2017 commodity forecast was for a Q1-2017 top, an important bottom
around mid-year and general commodity-price strength during the second
half of the year. The following chart shows that this turned out to be
exactly right, although some of our reasoning was wrong.
So, what's on the cards for 2018?
To use a cliche, 2018 will be a year of two halves for the commodity
markets and many other markets. To begin with, here are some of our
commodity-related expectations for the first half.
If we had written this forecast five weeks ago we would have stated that
the basket of commodity prices that constitutes the GSCI Spot Commodity
Index (GNX) was set to trend upward during the first half of 2018. That's
still our prediction, but due to the intervening price action there's now
a higher risk of it being wrong.
Risk has increased due to the recent sharp advances in the prices of some
commodities, most notably oil and copper. In particular, the approximately
$9 rise in the price of oil (West Texas Intermediate Crude) from around
$56/barrel in early-December to a high last week of almost $65 has
substantially reduced the intermediate-term upside potential of what is
still the world's most important commodity.
Oil and some metals, including copper, now look set to make multi-month
price highs within the first two months of 2018.
In oil's case, counter-balancing the extent to which price and speculative
sentiment are stretched into 'overbought' territory is the fact that the
fundamental backdrop remains bullish. As long as the supply-demand
situation in the physical market remains bullish, as evidenced by
significant backwardation in the futures market, it will be reasonable to
assume that nothing more bearish than a run-of-the-mill 1-2 month
correction is in store. We therefore expect that oil will exceed its Q1
price high during Q2.
In copper's case the fundamental backdrop is now neutral at best. This may
mean that whatever high is made by the copper price during the first two
months of the year will be the high for the first half of the year.
If the first half pans out roughly as expected then the second half should
contain a lot more downside volatility. In particular, we expect that a
substantial decline in the broad stock market during the second half will
lead to pronounced weakness in the prices of industrial commodities as the
dominant concern temporarily shifts from "inflation" to "deflation".
In the above discussion we singled out oil and copper, because these are
two of the small number of commodities that we follow closely. For most
commodities we have no opinion regarding likely price performance in 2018.
For example, we have no idea what will happen over the year ahead to the
prices of wheat, corn, cattle, hogs, cotton, sugar, lumber and coffee.
However, here are some additional brief thoughts on what we expect from
specific commodity markets:
We think that uranium made a long-term price bottom near $18/pound in
late-2016, but that a new bull market will not begin in the foreseeable
future. Uranium-mining stocks should, however, continue to be good for the
occasional short-term trade.
Due to a physical supply-demand situation that remains very supportive, we
think that zinc's bull market has a long way to go.
When platinum began trading at a discount to gold in 2015 we thought it
was a temporary state of affairs, but we now view it as a more-or-less
permanent shift. Rather than spikes below 1 in the platinum/gold ratio
signaling that platinum offers excellent value relative to gold it may now
be the case that spikes above 1 in this ratio signal that platinum is
expensive relative to gold. Long-term fundamental changes support this
conclusion, with gold benefiting from the increasingly
manipulative/counter-productive efforts of central banks and platinum
being hurt by the trend towards an all-EV world. That being said, we think
that there will be an opportunity to sell platinum in the $1200s (more
than 20% above the current price) during the first half of 2018.
We guess that natural gas will trade above US$4.00 within the first half
of 2018.
