2018 Investor Outlook

Can the Bull Market Continue?

I couldn’t think of a better time than now to share our 2018 Investor Outlook after the Dow plunges on seemingly no fundamental news and sets the record for the largest single-day point drop in history.

Wikipedia has already updated the record books by adding February 5, 2018 as the number one spot for “List of largest daily changes in the Dow Jones Industrial Average”

Coming in second is September 29, 2008, with a measly seven hundred point drop. The sell-off was amid growing concerns that our economy was artificially juiced by a massive corporate tax cut, and already at full employment, we risk overheating and could require forceful action from a new and untested Federal Reserve chairman. So the real question is, can the bull market continue?

Bull Case

The current bull market will be the longest in history if it continues to Aug. 22, 2018, while the outperformance of stocks versus bonds, at seven years running, would be the longest streak since 1929. Undoubtedly, the market delivered surreal gains since the election of Trump and in 2017 the S&P 500 notch 62 record highs. Looking forward, we recognize the bull market is entering the final stage but for how much longer? We see three main factors driving markets higher in 2018: corporate earnings, steady economic growth, and stable inflation.

1. Relatively strong corporate earnings have accounted for over 46% of the S&P 500 returns, dividends have accounted for over 21% and valuation expansion has accounted for the rest at 32% (numbers do not add up to 100% due to rounding). In 2017, almost 80% of the S&P 500 companies topped earnings estimates and we recorded the best earnings season in 13 years. Forward guidance also points to steady earnings in 2018 as ten sectors have higher growth rates today (compared to December 31) due to upward revisions to estimates and positive earnings surprises. Reference FactSet’s Earnings Insight.

2. Low probability of recession, the economy is close to being the second-longest recovery in our post-WWII history. The Bloomberg survey of economists, which provides insight into the consensus thinking at the time, currently stands at 15% probability of recession.

3. Low and stable inflation. In Janet Yellen’s final Fed meeting she did not raise interest rates. The decision, which came at the end of a two-day meeting, was widely expected. In the official statement “Inflation on a 12-month basis is expected to move up this year and to stabilize around the Committee’s 2 percent objective over the medium term.”

Seasonal Bull Case

When the S&P 500 returns at least 5 percent by Jan. 23, the index’s median gain for the rest of the year has been 11.6 percent, Bespoke Investment Group says.

In addition, Wall Street analysts have an average target for the S&P 500 at 2,861 by year’s end which is 8.1% higher from today’s close of 2,648. The S&P 500 finished 2017 at 2,673 soaring over 19%.

Wall Street expects bull market to make history in 2018 | MarketWatch

Bear Case

First off, what is a bear market? The term is sometimes thrown around loosely. But there’s a real definition that’s generally agreed on: A bear market is a downturn of 20% or more, lasting at least 60 days, in any broad equity index such as the Dow Jones Industrial Average, the S&P 500, or the Nasdaq. As of publishing the 2018 Investor Outlook, we are nowhere near a bear market, this is only a minor contraction which is viewed as a BTFD moment for particular groups of investors with calibrated time horizons. The last time the S&P 500 had a correction or a decline of 10 percent or more, was in February 2016.

However, no investor outlook is complete without an objective view of the bear case. Statistically, we are overdue. The most recent bear market ended in March 2009 — more than eight years ago.

1. Shrinking FED balance sheet, initially published September 29, 2017 in The Economist “The case against shrinking the Fed’s balance-sheet”

The headwinds could cause intermediate market turbulence with the new regime transition. The Fed has gradually been increasing interest rates to maintain control of inflation, and markets are beginning to react with the induction of Jerome Powell as the 16th FED Chairman. Mr. Powell is in charge with keeping the U.S. economy in the safe zone between overheating and recession. Higher rates on government bonds make stocks look less appealing. They also can make it harder for businesses and consumers to borrow and spend, possibly slowing the economy.

2. Inflationary concerns, on the flip side from our bull case of low inflation and stability backed by the FED’s statement other analysts are worrisome. The true CPI index increased 2.1% in the past 12-months and some believe it could pick up more steam. Nicholas Colas, co-founder of DataTrek Research think there’s a bigger risk than the FED, and that is fiscal policy. There is a risk, he writes, that the tax-cut bill signed into law in December proves “dangerously inflationary” and contributes to a Treasury market selloff.

Conclusion

“We cannot direct the wind, but we can adjust the sails.” – Aristotle

Barring any black swan events or increased geopolitical tensions, we are in the bull camp until any fundamental breakdowns in the economy or corporate earnings. Mark Vitner, senior economist at Wells Fargo thinks U.S. economic growth is now shifting into a higher gear. Economists surveyed by Wolters Kluwer Blue Chip Economic Indicators see it growing at a solid 2.6 percent, just under President Trump’s promise to deliver 3 percent plus GDP growth in 2018.

In addition, our nation’s record unemployment rate is expected to edge lower and tighten the labor market. In return driving wages higher and leaving employees with fatter paychecks to spend. Furthermore, Vitner expects tax cuts to spark more purchases, offsetting a pullback in auto buying. All told, the 52 economists surveyed by Wolters Kluwer expect consumer spending to increase 2.5% in 2018, roughly in line with last year, amid healthy job and income growth. Consumer spending makes up about 70% of the economy.

We expect the market to be volatile in the near term, to say the least as the global selloff spills into Tuesday, February 6th, as of writing this Dow futures point towards another thousand point sell-off. I’m crossing my fingers that we can look back on this volatile spat and relate the sell-off to a correlation in history. Note: The Fed chair Jerome Powell was sworn in to head the Fed Monday, with a more than 1,100 point Dow drop on his first day of work. He is not alone in seeing a decline on his first day. The S&P 500 fell more than 2 percent when Ben Bernanke started at the Fed, and it dropped almost 1 percent for Janet Yellen. Even sweet Janet caused a sell-off, so for those investors with long-term time horizons we see this as a buying opportunity and caution investors from totally divesting. We acknowledge relatively high valuations in equities, however, we believe these five major assets classes will outperform cash equivalents over the next three years ranking as follows:

1. Large-Cap Value U.S. Equities
2. European High Dividend Equities
3. Preferred Equities
4. Gold & Other Precious Metals
5. International REITs

The market may indeed reverse course in the coming weeks and go on to move higher by years end, allowing President Trump to start bragging again and possibly aiding Republicans in their efforts to tout the tax-cut bill and limit potential losses in the midterm elections.

For those with deeper risk concerns we advise completing a comprehensive risk analysis of your accounts which is available to our clients on demand and for interested readers, we would be happy to discuss your portfolio’s risk, let’s grow together 1-844-397-7767

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