By Stephen Kyne
As we turn the page on another year, it’s time to take a look back at all that was, and prepare for what lies ahead. For the economy at large, 2017 was a stellar year and we think there is more to look forward to in 2018.
We’re beginning to feel a bit like a broken record when we say that the year has been better than we expected, and we expect the next year to be good as well. Unfortunately, since 2009, many investors have remained on the sidelines and have missed the opportunities that the economy presented since the recession. The good news is that we think there’s still room to run in this expansion—even those shy investors have time left to participate.
This time last year, we expected that U.S. stock indices could easily provide returns in excess of 10 percent, and boy were we right!. As of Dec. 29, the Dow sits up about 25 percent, the S&P is up 18 percent, and the NASDAQ is up a whopping 29 percent for the year, while bond indices have returned in the neighborhood of 2 percent (barely pacing inflation).
Clearly, equity (stock) investors have been rewarded in 2017, as they have been ever since March of 2009. Loosening regulations, lowering corporate taxes and increased consumer activity have all been among the factors that contributed to an environment which is producing record corporate profits and ultimately the beneficiaries have been stock investors.
We expect that the same tailwinds that helped propel U.S. markets higher in 2017, will continue to positively affect the markets in the coming year. There are some who view record indices alone as a sign that markets are overheated and overvalued. These are the same people, largely, who haven’t had faith in the expansion since it began. We think they’ll be disappointed again in 2018, but their loss is everyone else’s gain.
When viewing equity prices in the context of corporate profits and prevailing interest rates, we find that U.S. markets are 10-15 percent undervalued as we enter the new year. GDP has remained in the 3 percent range at each quarterly checkpoint this year, and we believe that growth will continue to lift markets, as well.
Not every sector of the market will enjoy the same levels of growth. Technology and financials will likely outpace sectors like utilities and consumer staples.
As for tax reform, no matter on which side of the political aisle you sit, it is fairly universally agreed that, at minimum, the tax legislation recently enacted will greatly benefit U.S. corporations. However you feel about that is irrelevant, from an investment standpoint.
The accepted fact remains that lower corporate tax rates should lead to greater bottom-line profits and that will benefit shareholders. Who are those shareholders? You. If you’re planning for retirement and have any money invested in equities or equity funds in your IRAs, 401k, 403b, TSA, etc., then you will be a direct beneficiary of tax reform, whether you agree with it or not.
U.S. bond markets should continue to under perform, as the Fed continues to raise interest rates. We expect increases in 2018, with rates ending next year at 2.25-2.5 percent. It should be noted that, while the Fed is raising rates, it’s not being done for the traditional reasons.
Often, rates are increased to slow an overheating economy, but current increases are aimed at a return to normalcy. In other words, since lowering interest rates is a way for the Fed to jump start a slowing economy, if rates were to continue to remain low, and a recession were to begin, the Fed would not have access to its primary tool, so think of the Fed’s current actions as “reloading” for next time. In this way the Fed is not becoming “tight,” it’s simply becoming “less-loose”.
International markets should continue to perform well in the coming year. For the first time since 2009, the U.S. was not the only ox pulling the plow, and we saw growth in both emerging and developed economies abroad. The strengthening U.S. consumer, and a relatively strong dollar, are drivers of growth in countries that export to the U.S. If invested for growth, we believe it is wise to consider deploying a portion of one’s portfolio abroad.
On the spectrum of international equities, we believe there remains more upside potential in the emerging market space, than in developed markets, with relatively more risk as well. Southeast Asia remains a relatively attractive region, while Latin American countries continue to be affected by the same social and economic strife that has hampered them in the recent past.
With the exception of a major geopolitical event (i.e. North Korea), we believe 2018 will be another year in which equity investors can reap great rewards for taking, even moderate, risk. The fundamentals of the U.S. economy remain extremely strong, as it continues to help propel worldwide equity prices higher.
Remember that everything written here is a forward-looking statement, based on our view of the markets and economy today. Any number of domestic or foreign events could drastically alter our outlook.
Your exposure to the various equity and bond markets should depend on your needs for return and you inherent appetite for risk. Be cautious about overextending, and be sure to consult with your financial advisor to help ensure that any changes in the economy and markets are reflected in your portfolio, and that your portfolio remains reflective of your needs and goals.