Global markets keep advancing, for very good reasons

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A man incarnating a ‘Toro de Fuego’ (bull of fire) chases people during the San Fermin Festival on July 8, 2017, in Pamplona, Spain.

Also, tax cuts have added fuel to record earnings. Instead of S&P earnings growth of roughly 10 percent in 2018, strategists and analysts are expecting growth of 15 percent or more. Just this morning, UBS strategist Keith Parker raised his 2018 S&P forecast to a gain of 18 percent. Of that, 7.2 percentage points (40 percent) is attributed to the influence of tax cuts.

Another factor is subdued inflation. That means the Federal Reserve remains on a slow, well-communicated rate hike path. The hottest debate among traders is whether a stronger economy will necessarily entail much higher inflation, which is a tenet of economic theory for decades. But everyone knows about the deflationary forces in the economy (many prices are going down, not up), so unless the economy significantly overheats it’s not clear how strong this connection is any more.

It’s important to remember that historically the two biggest killers of bull markets have been recessions and aggressive Fed rate hikes (which are often related).

Inflation worries and a Fed suddenly turning aggressive are probably the strongest arguments the bears have now. But that is still a story for March, when the next Fed press conference happens.

The other bear argument — that the stock market is expensive — falls into the category of statements that are true but not interesting. The S&P is now trading at close to 20 times 2018 earnings, which is high historically, but when earnings growth is well above normal (as it is now) multiples tend to decline, a point made by Parker in his note this morning.

The key point is this: when you are witnessing an economic expansion with a concurrent rise in earnings, multiples can be, and historically have been, higher than normal.

The final bear argument points to an exogenous event such as a terrorist attack or a serious conflict with North Korea. That is certainly a real concern, but the markets have learned not to price in these events unless they are imminent. You can argue that this is not prudent, but given the modest market impact from terrorist events in the past decade it is not an irrational position.