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As the writer of this column and a daily market commentary I frequently present analysis and express views suggesting that several markets, including stocks, are likely to correct lower and that the economy is performing below potential. My analysis and views are based upon a strong belief and reliance on free market principals; something government policy, including Federal Reserve monetary policy, has moved away from over the last several years.

I have been generally wrong about stocks; I would have thought that a substantial correction would have occurred by now.

If you are on the other end of the economic theory and political belief spectrum than I am, you might also be asking yourself if things could really be as good as the stock market has suggested over the last year and continues to forecast given its seemingly unstoppable advance.

What’s going on? Are we both wrong? Did the policies of the Obama administration really drive markets to all-time highs, and is there that much optimism in the Trump administration’s policies that stocks have now set an all-time record of 12 consecutive months of gains without a single down month? Can things really be this good?

Some broad measures of economic activity such as the unemployment rate have been good for several years. Other broad measures of economic growth such as gross domestic product have only recently turned more positive. Measures of wage and income growth are mixed while official measures of inflation remain muted. Housing numbers are strong. Consumer confidence is high.

Leverage is also high. Government debt has more than doubled in the last 9 years, corporations have been on a borrowing binge, and stock market margin debt which allows investors to borrower money against the value of their portfolio in order to purchase additional shares is at all-time highs.

Leverage works great when prices go up and volatility is low as is currently the case. Measures of backward looking market volatility, known as realized volatility, are at all-time lows. Forward looking measures of market volatility such as the VIX are also at all-time lows.

As far as corporate earnings go, for those companies included in the S&P500 index, earnings fell for much of 2014, 15, and 16, but have increased in 2017.

The Trump administration and Republican controlled congress are trying hard to make tax reform happen, including a substantial reduction in the corporate tax rate.

Market conditions sound pretty good. A record number of investors currently think that stocks will be higher in a year than they are now, and a record number of investor newsletters are forecasting the same thing.

All the market enthusiasm almost makes me want to change my views, leverage up, and go all in stocks.

But I can’t. I learned a long time ago that profitable trading and investment management is as much a function of discipline as it anything. A quantitative, unemotional approached must be followed.

I will adhere to my stringent beliefs free markets coupled with prudent risk management.

I will hold fast to my free market principals and beliefs that it is ultra-low borrowing costs as engineered by the US Federal Reserve over the last several years that have increased corporate leverage, facilitated share buy-backs, and increased per share profitability. This has come at the expense of future investment and earnings.

The Federal Reserve has distorted market prices and caused the inefficient allocation of capital.

As engineered by the Federal Reserve, yield seeking investors have been pushed into stocks, driving up prices and ratios of fundamental value which leaves stocks vulnerable to a substantial price correction.

Furthermore, the economic optimism which fueled stock gains over the last 12 months risks dying every time the Senate votes.

Additionally, there are too many global geopolitical risks to list, but a Chinese debt bubble is on the top of that list.

I’ll stick to my fundamental views of what drives the economy and market. I might be wrong in for several more months or even a year, but in the end I am confident that I will be right. I will remain disciplined. And, most importantly, I will continue to strongly advise that you ensure that your portfolio is well structured. Things just can’t be this good.

Unless you live in Montana, hunting season is here, and ski season is about to start!

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Barry Nielsen, CFA, works at Opportunity Bank of Montana, Helena branch.


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