“But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?” – Alan Greenspan

As 2018 approaches us, I’ve fallen prey to my usual year end vices of eating and drinking way too much over Christmas. This inevitably puts me into a very contemplative mood about the year that has passed as I try to wrangle with the guilt from all the gluttony.

Between the highs of holiday cheer to the lows and slight depression that ritualistically ensues the morning after, I find this year end cycle to actually be somewhat helpful for me to plan and prepare for the year ahead.

A few years ago I would have kept partying all the way until New Year’s Day but after having kids and committing to a renewed focus on my health and fitness, I make it a point to not begin the New Year with a hangover anymore.  

As such, I use the days between Boxing Day and New Year’s Day to level-set myself both mentally and physically which in turn helps me attack the year ahead at full speed.

Market volumes always tend to be extremely light this final week and many investors take to my old euphoric partying stance when trading into year end, often bidding up stocks on thin volumes. Fund managers also join this practice by participating in their annual “window dressing” ritual to try and end the year on a high note.

I’m not here to tell anyone how to trade their own book, but it would be remiss of me not mention the handful of risks that I cannot help but be weary of for the year ahead.

Earlier in the month we saw the Fed (and global) tightening continue with future increases also being advertised well in advance. This has caused some pressure to build up in the US Treasury market, namely in the yield spread between the 10-year and the 30-year which have flattened 50 bps since September.

This is much tighter than the usual range of 100 bps and reflects aggressive positioning by speculators in the 30-year bond futures, who expect Fed tightening to significantly weaken US growth.

This, however, does not seem to be the consensus of equity investors as the S&P Index is clearly not reflecting the same view of the US economy that the fixed income traders are taking.  

Equity market euphoria continues to be at all time highs and sadly there cannot be two winners in this zero sum game.

Either the equity market is right or the bond market is right and only time will tell if a stronger growth consensus of the US economy emerges, which would spark a sell-off in Treasuries as more money rotates out of bones into equities at nosebleed valuations.

To the casual retail investor this may be seen as an increasingly bullish sign (which would make the case to keep longing the XIV) but combine that with the ongoing euphoria (read distraction) we are seeing from cryptocurrency markets, and it’s quite easy to see that the market is vastly underpricing the risk of higher volatility in the coming year.

Asia is not immune to shocks from potential higher volatility either, as we’ve seen the equity markets over here also trading at euphoric highs.

The Heng Seng Index has printed an astonishing 35% return this year with the vast number of the other regional emerging markets (China, Japan, Korea, Taiwan, Indonesia, India) all punching in solid double digit returns.

The Hong Kong property market continues to be the darling asset class of choice with the Centa-City Leading Index (CCL) last posting at 165.30, hitting historic highs, up 0.51% from the previous week. The index set five new highs in seven weeks, indicating an obvious uptrend.

Source: Bloomberg

As much as Asian investors love to let their winners run, a slight reversal in sentiment is all that would be necessary for us to see a powerful rotation away from the market leaders of 2017 and into the laggards next year.   

When someone is used to making money a certain way for too long, they often forget that it may not always be that same way in the future. As the multi-year era of QE comes to a close most investors have gotten used to making money from the stock market, on growth and dividends.  

As investors we all know that this type of euphoria cannot last indefinitely.

And when it ends, we always see some major market moves.

For most of us investors, we’ve worked hard all year and hopefully have locked in some good gains in our portfolio.  

So for now, we can dedicate these last few days to reflecting on the year that has passed, planning for the year ahead and of course focusing on the things that are most important in our lives, such as spending time with family.

I want to wish all of you a Happy New Year!  I look forward to continuing this journey together next year (week) and will see you in 2018.