Here's what you can expect from the stock market in 2018 – Yahoo Finance

By David Nelson CFA

Sentiment coming into 2017 was mixed, mostly divided around political affiliation. Those in support of change pointed to aggressive growth expectations on the heels of tax reform and deregulation. On the other side, economists like Nobel Laureate Paul Krugman believed expecting anything approaching 3-3.5% GDP was little more than economic arrogance.

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Investors have cast their votes driving up U.S. stocks more than 20% in 2017. Today, as we approach the end of the year it’s natural for those same investors to turn their attention to 2018 and beyond. It’s a ritual as old as markets but fraught with risk. After a 20% rise in stocks Wall Street has become unquestionably bullish with Oppenheimer’s John Stolzfus already announcing an S&P 500 target of 3000 for next year. Even Goldman which spent much of the year focused on the downside is looking for a modest rise on the heels of tax reform.

One thing about crystal balls. When you look at the beginning of the year they seem decidedly clear with all but a GPS moving map showing us the path down the Yellow Brick Road. Unfortunately, just when you need it most it starts to malfunction failing to alert you when the Wicked Witch of the East zooms in for the kill.

The danger in these predictions is that more often than not we extrapolate recent history into the future. If the market was up in the last year, than by all means it should continue. If we’ve been in a prolonged downturn than of course expect markets to continue to struggle.

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The most dangerous predictions of all are those that go out 3-4 even 5 years. Anyone making long term predictions about how something as complex as the world economy is going to react 5 years from now, is likely on par with my prediction the New York Jets will re-sign Joe Namath and win the Super Bowl in 2020.

The above doesn’t make predictions a useless exercise. It’s ok to plan ahead but explore both sides of the issue knowing that your opponent’s crystal ball may be more accurate than your own.

I currently fall into that same camp as many extrapolating 2017 a very good year into the next. PMI data around the world points to geosynchronous growth which doesn’t happen all that often. Strength in overseas markets means our customers are doing well and that’s great news for U.S. multinationals.

Markets are driven by all sorts of factors but in the long run they follow earnings. There are any number of items in this tax bill I don’t agree with but if the corporate rate comes in anywhere close to 20%, then 15% earnings growth is doable. $150 in S&P earnings isn’t out of the question.

Add the fact that these very same large caps will get access to a couple trillion dollars parked off shore and the picture looks pretty bright. The question is; what will they do with it? I’ve been critical of CEOs for focusing too much attention on buybacks. I believe, we’re at the beginning of a capex cycle as CEOs understand that they have to start growing the top line if they want to remain competitive.

Buybacks are slowing

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Buybacks have already started slowing, peaking in early 2016. You’ve heard me say this in any number of interviews; “the next leg of the bull market isn’t going to come on the heels of financial engineering.” There are too many examples of buyback casualties that bought back their own stock at higher prices effectively destroying capital.

Here’s where I could be wrong

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Trouble in the stock market often shows its colors in bond markets first. After a decade of quantitative easing we are coming to the end of one of the greatest financial experiments in history. The U.S. is the first venturing down a path to normalization as it begins to unwind a $4.5 trillion balance sheet. Even if successful, we will see sequels as both the ECB and the Bank of Japan will go down this same path in coming years.

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U.S. Treasury curves and spread charts between long and short duration bonds point to a flattening curve — an often ominous sign for stock investors. Historically, a flat curve has been an early warning sign that we we’re in the early stages of recession. Just what is the bond market saying that stock investors seem to be ignoring? Dan Fuss, legendary bond investor for Loomis Sayles, said in a recent Bloomberg TV. interview that the U.S. economy is strong and has cut maturities in half.

If the economy is as healthy as the stock market suggests why then are some institutional investors still willing to lock up funds for 3 decades accepting an annualized return of well less than 3%?

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A businessman is consulting a crystal ball to foretell the future. Source: InfoWire.dk/Flickr

A projected $150 in S&P earnings is predicated on tax reform making its way to the President’s desk before the end of the year avoiding the start of the 2018 election cycle. Given an army of lobbyists on the hill each fighting for a different tax loophole and two different bills from both the House and the Senate to resolve, almost anything can happen.

Finally, nearly every corner of the planet is a geopolitical hot spot as the world careens from one crisis to the next. To date, investors have looked the other way because doing anything else simply hasn’t been profitable. Of course, that line of thinking only holds as long as geopolitical threats don’t spill over into the real economy and earnings.

Whatever your process, adjusting your market exposure on the heels of every tweet, breaking news banner or rumor has probably kept you in cash for most of the last decade. Follow the money! Stocks are about earnings, dividends or both. Valuations don’t live in a vacuum. For now stocks relative to other asset classes like Treasuries seem to offer more.

Could I be wrong? You bet and I’m sure everyone reading this article will let me know just how wrong I was. No worries. It comes with the territory.

See also:

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Warren Buffett is sending the wrong message on Wells Fargo

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