Summary Projections for 2018:
- Positive single-digit returns
- Increased volatility
- Outperformance in international, value and possibly small and mid-caps
- Challenging bond market
Whenever the bulls run in Spain, I watch with fascination as they plow through the streets picking off runners left and right. Last year I watched with the same fascination as the stock market picked off new highs…20,000, 21,000, 22, 23, 24, and finally 25,000 on the Dow… one by one, like skinny young Spaniards flailing in the street. And to the surprise of many it did so with relative ease, as I discussed in my 2017 market review.
Now, the question everyone is asking is, “How long will this bull run?” The short answer: this bull likely has plenty of room to run.
You may be thinking, “this bull has run for nine years, and the average bull only runs for 4 or 5.” And this is true. But here is why this bull still has room to run:
- Slow Expansion: Due to the severity of the great recession, this economic expansion gained steam much more slowly than the average recovery… and has taken much longer to get up to full speed. So far, this has kept it from “overheating” with inflation or any of the other excesses that tend to end a bull market.
- Close to Full Steam: The economic engine behind the markets is now close to full steam, if not already there. GDP has been flirting with the long-term average of 3%. Unemployment is at a 20 year low of 4.1%, projected to go lower. Manufacturing is up. Retail sales are up. Inflation is tame. Corporate earnings continue to rise and the recent tax reform should continue this trend for some time. The Conference Board and the Wall Street Journal’s monthly Survey of Economists both expect this economy to continue growing. And the Fed is raising interest rates based on expectations that this economy will continue growing.
- Low Interest Rates: When the economy begins overheating, the Feb will begin tapping on the brakes by raising the Fed fund rates above 4% or so. We are currently far below that. The current fed rate increases are more like just letting off the gas.
- Global synchrony: International economies have now begun expanding again, after years of struggling to come out of their own recessions. This is fueling a positive feedback loop around the globe, with the fewest number of countries in recession in history.
Although we expect this bull market to keep running, it will have its challenges in 2018, though none are expected to bring on an all out recession at this point:
- Inflation & Interest rates: as unemployment drops further, wages will likely increase and begin driving up inflation, at which point the fed may become more aggressive in interest rate hikes. This rise in wages and inflation is not expected until 2019, but if it comes early this year it will be a challenge for both stocks and bonds. Keep your eye on inflation.
- Geopolitics: N. Korea is just the latest example of something that could set off a fear-led correction in markets.
- Over-valued Markets: the stock market, according to S&P 500 earnings levels, has been slightly overvalued for the past year and a half or so. It typically “corrects” back to normalized levels in small pullbacks throughout the year. With no significant correction in the past 1.5 years, the markets are overdue.
When the positives and negatives are weighed, the scale tips toward continued growth for 2018. Now for more specific projections:
- Positive Single-Digit Returns: based on the over-valuation of U.S. stocks, I expect they are likely to return less than last year as we wait for the economy and corporate earnings to catch up to market levels. Returns in the 6-9% range would be reasonable.
- Increased volatility: Again, markets are overdue for a correction, and 10-15% pullbacks at some point each year are normal. And it won’t take much for markets to be more volatile than last year, one of the calmest markets on record.
- Outperformance in international over U.S.: While U.S. Markets are overvalued, international markets are undervalued, and many are coming out of recession, the time when markets often do best. Emerging markets may see the best returns again this year.
- Challenging bond market: as interest rates rise we may see bond values drop. But probably not by much, if at all. International bond buyers seeking higher and safer yields than abroad will likely continue to bid up prices on U.S. bonds, keeping values propped up. But at some point I expect that to reverse. Most bond guru’s don’t seem to think that will be in 2018. Still, there’s little additional payoff for being long in bonds right now. The sweet spot seems to be in 5 yr duration. Inflation protected bonds are also probably a good place for some of your bond allocation this year. And if you have bonds as a hedge in your portfolio, it’s a good time to upgrade from low grade bonds with higher yields but higher risk, to high grade bonds with lower yields but lower risk.
Summary
It looks like 2018 will be another good year for investors who are willing to tolerate the volatility as markets get back to their normal “ups and downs.” For clients who have put together a diversified portfolio based on long-term planning goals, this market volatility should not be a concern, and they will likely be rewarded.
We hope you enjoy the running of the bulls in 2018!
Greg
If you would like to discuss this article, please call me at 316.440.2550
