Bull Case vs. Bear Case: 4th Quarter 2017

It’s really hard to predict the future. That’s why I don’t try to time the market and just buy a diversified set of low-cost index funds.

One of the reasons why it’s so hard to time the market is that there’s always a strong case that the market will rise and a strong case that the market will fall. Either scenario seems equally plausible, making it difficult to make money on predicting global macroeconomic trends.

To illustrate this point, let me present to you the bull market case and the bear market case for the final 3 months of 2017. Hopefully both scenarios seem realistic to you, showing that we just don’t know whether we’ll continue to make all-time highs in the stock market or experience a correction or bear market.

I make no guarantees that any of my predictions will come true, but I’ll be (half-right) no matter which way the market moves.

Third-quarter 2017 Market In Review

The stock market continued to roll in the third quarter of 2017. Here’s how the three-fund portfolio performed in the third quarter of 2017:

Source: Morningstar

International stocks continue to outperform U.S. stocks in 2017, reversing several years of underperformance. A case can be made to include or not to include international stocks in your portfolio, but hopefully you’re not jumping into international stocks now only because it has been doing well.

The Bull Market Case for Q4 2017

The stock market has had an incredible run over the past 8 years. The market has more than tripled since its low in 2009, with only a few hiccups along the way. Just because the stock market has gone up 8 years doesn’t mean it can’t go up for another 8. After all, the bull market of the 1980s and 1990s lasted 18 years.

Tax Cuts

Donald Trump has made tax cuts, particularly corporate tax reform, a high priority for his administration. He promised reforming the corporate tax system to help bring money and jobs back to America. Now that healthcare reform has been defeated in Congress, he has recently proposed a tax bill to Congress, which will be debated in the coming months.

The predominant reason why the stock market moved up so sharply after Donald Trump’s election was because of the belief that a Republican administration would promote pro-business policies. That has largely not happened so far. A victory for Donald Trump and the Republicans in passing corporate tax reform and other pro-business policies would push the stock market to new heights.

Corporate Earnings

The latest batch of corporate earnings show that the American economy is strong.

You don’t need to look just at corporate earnings to see that the economy is growing. You just need to look in your own neighborhood. Housing prices are going up sharply, exceeding the 2007-8 high in many American cities. People are spending more, albeit most of the gains are online rather than in malls.

Economic Growth

The economy is growing, with GDP going up 3.1% in the most recent report from the government, and America has added over 1.4 million jobs in the first 8 months of 2017. It feels like every retail store or restaurant you to go these days are hiring. The job market is heating up in medicine too, where tight job markets in specialties like radiology are improving.

In short, the state of our economy is good, and there is potential for the good times to keep on rolling. Those who have been predicting a bear market over the past few years have been burned.

The Bear Market Case for Q4 2017

The bear case can be summarized by two words: Trump and valuations.

Donald Trump

Donald Trump is the most polarizing politician in recent memory. You either love him or hate him. If you hate him, you worry that he will bring down the U.S. economy, or the U.S. in general, with a single tweet.

Most recently, he has been engaging in sabre-rattling with North Korea. Escalating tensions could lead to geopolitical instability. Instability and uncertainty is never good for the stock market, and Donald Trump, even 9 months into his term, has brought a lot of uncertainty to Washington and the U.S. economy.

He promises to bring tax reform to the United States, and the stock market has been buoyed by the belief that he will pass pro-business legislation. However, he has been unable to unite the Republican party behind his policies. The Republicans’ inability to repeal Obamacare and pass healthcare reform shows that he may not be able to pass tax reform either. A failure to pass tax reform would sink the stock market, which has been anticipating a tax cut since his election.

Valuations Are Too High

For many, this 8-year bull market is becoming long in the tooth. Valuations, measured by P/E ratios or the Case-Shiller P/E ratio, show that the stock market is at a higher level than historically. If the Case-Shiller P/E ratio moves back to its historical average, the stock market will fall. At a minimum, the stock market is headed towards a period of below average returns. Even very well-reasoned analysts like Early Retirement Now are pricing in a period of sub-average returns, recommending that people nearing early retirement use a withdrawal rate of less than 4%.

Conclusion

A strong case can be made for a bull market or bear market over the next 3 months. Because we don’t know which case will pan out, don’t try to time the market. Stick with your current asset allocation, and tune out the daily market movements.

What do you think? Is the bull case or the bear case more convincing to you?  Would you like to make a prediction about the movement of the stock market in the next 3 months?

[Charts courtesy of StockCharts.com]