The Star Tribune Investor Roundtable discussion (by Patrick Kennedy 12/31/17) predicted another strong year in the market. We at Olson Wealth Group enjoy an intelligent level of debate so we decided to offer our own Market 2018 Outlook.
Why were so many analysts off on their 2017 stock market predictions?
Annual returns for the S&P 500 over the last five years have ranged from 32% to 1%. It’s such wide range of returns and it’s such an inexact science that we look for averages. One single year is also a small sample size when you’re talking about the equity markets which, on average, return 8-10 percent long term.
To answer your question, corporate earnings came in stronger than expected. Even with the Trump Bump at the end of 2016, we don’t think anybody foresaw the broad-based increase across the board, including energy. Corporate earnings are the one thing that drives everything. Also, technology shares led the way. They have underperformed over the last 3-4 years but were fueled by tail winds like new products and cloud computing. This helped to drive the entire market.
How long can this bull market last and what shape does it take going forward?
The stock market did a lot better because energy earnings were coming off a historically bad period and they normalized last year. This gave an unnatural lift to corporate profits.
Volatility is probably the biggest story of last year. It was non-existent. Almost in any case, volatility is going to eat at returns. So, when you have record low volatility, you should expect better than the average returns. Given where evaluations and debt levels are right now, we expect the long term trend in the bull market to continue.
The biggest fear to this current bull market is an increase in interest rates. Normally, what causes the end of these bull markets is when the Fed falls behind in their interest rate policy and raise rates too quickly. This usually puts an end to whatever growth is left in the market.
What things should investors keep their eye out for?
Investors still seem to be missing adequate exposure to international equities. Since 2009, foreign markets, in terms of U.S. dollars, are only up about a third as compared to the U.S. stock market.(1) That gap should continue to close which means that international should outperform the U.S.
Over the last year especially, there’s been a big disconnect between growth equities (ie: companies who don’t pay dividends and may have a lot of debt), and value equities (ie: companies with strong balance sheets that pay high dividends). We feel that value equities will spring back so this is the time to take advantage of those.
We’re also looking at infrastructure spending and tax reform. A lot of that has a disproportionally positive impact on medium and small cap companies which the market hasn’t fully appreciated yet. Look for those to outperform as well.
Are there other alternative investment or investment ideas that are attractive right now?
We are focusing some of our attention to Environmental Social Governance (ESG) investments. Historically, investors have had to accept a diminished return in order to fund projects for societal benefit. However, a move towards stronger governance seems to be affecting returns. A recent Harvard study found that ESG returns are more competitive and could outperform traditional investments.(2)
In addition to small caps and value equities, some of our heroes include cyclical stocks and emerging markets. Other unsung heroes include growth stocks in the tech sector and high-yield corporates and bank loans. As always, we strive to maintain a long-term perspective and well-balanced portfolios.
What is the 2018 outlook from LPL Financial?
Traditional business cycle drivers are expected to take a larger role in spurring further economic and market growth in 2018, as we have experienced a fundamental shift in the forces behind this continued economic expansion.
For the majority of this economic cycle, accommodative monetary policy has supported growth and the markets have relied on central bank intervention to keep the expansion going. There has already been directional change by the Federal Reserve (Fed), coupled with companies’ increased need to focus on growth, resulting in a new dynamic for business leaders and investors.
Given this shift, LPL Research believes the return of the business cycle will be characterized by:
- Fiscal coordination, with some combination of infrastructure spending, tax reform, and regulatory relief. Given recent progress on the policy front, corporate tax cuts could be a primary contributor to economic activity in 2018.
- Business investment in property, plants, and equipment. Companies are using cash differently now, focusing on increasing productivity and attaining greater market share.
- Earnings growth, supported by better global growth, a pickup in business spending, and potentially lower corporate taxes.
- Active management, which should see continued momentum thanks to a return to fundamental investing, where investors can determine winners and losers based on earnings, sales, cash flow, and so on.
Against this backdrop, the U.S. economy—as measured by gross domestic product (GDP)—is expected to grow at a rate of 2.5%, thanks to fiscal support, a pickup in business spending, and steady consumer spending. LPL Research forecasts returns of 8–10% for the broad stock market (as measured by the S&P 500 Index), with earnings growth the primary driver. And given expectations for a gradual increase in interest rates, bonds may see flat to low-single-digit returns, as measured by the Bloomberg Barclays U.S. Aggregate Bond Index. This return to the business cycle has the potential for success, however, an aging expansion and a leadership transition at the Fed may increase the likelihood that stock market volatility picks up in 2018.
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(1) J.P. Morgan Guide to the Markets 1Q 2018, p.45.
(2)https://dash.harvard.edu/handle/1/14369106:Corporate Sustainability: First Evidence on Materiality.