Reprinted courtesy of the National Post
by Tom Bradley

“Portfolio managers are a paranoid lot. When times are good, we worry about when it’s going to end. When times are bad, we worry that it’s never going to end.”

Don Cranston, the C in CGOV Asset Management, told me this years ago. He could’ve been referencing 2017, which for me, was a year of discomfort. It just felt too good.

After years of markets over-reacting to political and socio-economic news (remember the gyrations around Greece and the political gridlock in Washington), nothing could shake investors in 2017. The Brexit negotiations were going badly. No problem. NAFTA looked even worse. Ho hum. Korea has the bomb. It won’t happen. China is trying to rein in debt. For sure it won’t happen. And Trump’s tweets? Well, just entertainment.

In light of this macro complacency, stock market volatility has been as low as it gets. There have only been three days this year when the MSCI All-Country World Index was up or down more than one per cent, and none over two per cent. The stock market was calmer than Tom Brady in the fourth quarter.

Meanwhile, the factors that really drive stock prices kept getting better. We had broad-based economic and employment growth, and hyper-stimulative interest rates. Talk about a great combination — a strong economy and crisis-level monetary policy. Investors had central bankers in their pocket.

With business activity came healthy profits. Year-to-date, operating earnings for the companies in the S&P 500 Index are up in the neighbourhood of 20 per cent. Low rates, cheap energy and continued industry consolidation all helped the cause.

And as for valuations, which are always the biggest swing factor for asset prices, the ratios stayed high or expanded further.

For instance, in fixed income, interest rates started to rise in the summer, but this normalization quickly petered out. Government of Canada 10-year bond yields remain below two per cent, and in Europe and Japan there are US$11 trillion of bonds trading at negative yields.

With rates so low, a major feature of 2017 was the availability of credit to anyone who wanted it. Lower-rated corporations and governments issued bonds at remarkably low yields and were able to do it with a minimum of restrictive covenants. Buyers of high yield bonds didn’t appear to be worried about the risk of default. The poster child for this trend came in June when Argentina issued 100-year bonds with a coupon of eight per cent. The offering was three times over-subscribed, even though Argentina has defaulted five times in the last century, most recently in 2014.

As mentioned, stock prices were supported by growing corporate earnings, and the multiple on these earnings stayed at a historically high level. Normally record profits garner a lower price-to-earnings ratio in anticipation of more challenging times ahead, but so far this hasn’t been the case. And high multiples weren’t limited to the public markets. Recent data from Pitchbook shows that private equity firms are paying a 20 per cent higher earnings multiple for acquisitions than they were five years ago.

As this combination of positive drivers came together and my year of discomfort developed, there was one other major development. Warren Buffett’s ‘Fear versus Greed’ meter moved decidedly towards the Greed side. Consumer confidence rose to cyclical highs in Canada and the U.S., and investor confidence went along with it. People are bullish again. As one of many pieces of evidence, it was reported that cash held in Merrill Lynch client accounts is now at the lowest level (10 per cent) since 2007. For context, the high mark was at the market bottom in March of 2009, when fear was rampant and cash levels hit 21 per cent.

And of course, we can’t forget Bitcoin. This kind of speculative eruption doesn’t happen when investors are fearful.

Strong market returns and positive investor sentiment reflect the fact that all the ducks were lined up in 2017. There have been many years when returns were better, but most represented recoveries from market selloffs. Not the case for 2017. It was the ninth year of a bull market.

Will the ducks stay in formation for a 10th year? Will investors’ mood remain positive? I’ll weigh in on 2018 in my next column. In the meantime, have a happy (and hopefully less paranoid than mine) holiday season.