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Ten predictions for 2018: 1Q update
Equity markets on a wild ride to nowhere
- Q1 in review: Economic and corporate fundamentals remain sound, but trade issues and rising interest rates and inflation remain risks.
- A look ahead: It’s early, but most of our predictions are trending in the right direction.
- Key themes for investors: Investing is likely to be challenging from here. Security selection will remain critical.
Our overall theme for the year is that we expect 2018 to be “less perfect” than last year, as we see continued decent economic growth and corporate earnings, as well as low but rising inflation and yields. We also anticipate more market volatility and less of a tailwind from the political backdrop. It’s early, but so far 2018 is generally shaping up as we expected.
Ten predictions for 2018
U.S. real GDP reaches 3% and nominal GDP 5% for the first time in over a decade.
First quarter economic growth is looking to be weaker than anticipated at the start of the year, with consensus expectations for real GDP growth declining from the 2.5% to 3% range to 2% to 2.5%.2 We expect growth to rebound in the second quarter and beyond, especially given the strength in the labor market and a tailwind from additional fiscal stimulus. With inflation climbing modestly, we also believe that nominal growth should climb.
Despite ongoing protectionism, the global expansion continues with the fewest countries in recession in history.
Rising trade protectionism is a genuine threat to the global economy. In our view, trade tariffs are effectively taxes and drive a wedge between producers and consumers. So far, however, the world economy has been able to look past these issues as economic growth around the world remains relatively strong.
Unemployment falls to the lowest level in nearly 50 years as wage growth is the highest since the Great Recession.
The latest data show that unemployment is down to 4.1% and wage growth is trending at 2.7% year over year.1 Unemployment is already close to its 50-year low of 3.9%,1 and we think there is a good chance we’ll see that level again in 2018. Likewise, we expect wages to rise to nearly 3% growth by the end of this year.
The yield curve flattens (but does not invert) as the 10-year Treasury yield reaches 3% for the first time since 2014.
Yields have moved erratically over the last three months, but have generally trended in the direction we expected. The spread between the 2-year and 10-year Treasury yield narrowed from 52 basis points to 47 over the quarter, and the yield on the 10-year came close to 3% before retreating.2 We expect both modest flattening and unevenly rising yields to continue as financial market themes.
Stocks enjoy longest bull market in history but experience a 5+% correction after the longest period without one.
The second half of this prediction came true in February when stocks experienced their first significant correction since 2016.2 Should equity markets make it to 22 August this year without the bull market ending, the first half of this prediction will come true as well.3
U.S. equity returns lag earnings growth for the first time in six years, the longest streak in decades.
So far, this prediction is coming in as we expected. As of the end of the first quarter, estimated 2018 earnings-per-share growth for S&P 500 companies was 19.7% year over year, significantly ahead of equity returns.3 It would take a massive collapse in earnings and/or a sharp jump in prices for this prediction to move into the “wrong” column.
Equities beat bonds for the seventh consecutive year for the first time in nearly a century.
As of the end of the first quarter, stocks were down 0.8% and bonds were off 1.5%.2 Given higher levels of volatility in both markets, we’re not comfortable marking this one as heading in the right direction quite yet. We think stock prices will end the year higher, but need to see more clarity before we grow more confident.
Corporate capital expenditures increase at the expense of share buybacks.
Capital expenditure levels are picking up, a trend we expect will continue into 2019.4 Corporate tax cuts have had a positive effect, as have the weaker dollar, still-narrow corporate credit spreads and rising energy prices. Rising protectionism, however, represents a risk to higher cap ex levels. Companies are likely to continue buying back their own shares, but also have many additional options when it comes to spending their cash.
Telecommunication services, information technology and health care outperform utilities, energy and materials.
Results are pretty jumbled given market volatility, but this prediction is trending in the right direction so far. A basket of our most-favored sectors is down -1.7%, while a basket of our least-favored is down more at -4.9%.2
Republicans lose the House, retain the Senate and further distance themselves from President Trump.
Absent a significant shift in the political landscape, we expect Democrats will be able to take the House of Representatives in November, although the Senate is less likely to see a leadership shift. We have already seen a number of high-profile Republicans distance themselves from the president, especially on the issue of trade. Now that tax reform has passed, there appears to be less of a political price for GOP members to disagree with President Trump.
Video | Bob Doll Market Update: May 2018
1 Commerce and Labor Departments
2 Bloomberg, FactSet and Morningstar Direct
3 Bank of America Merrill Lynch Research
4 Morgan Stanley Research
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-investment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. An alternative strategy sells securities that it has borrowed but does not own ("short sales"), which is a speculative technique. A strategy will suffer a loss when the price of a security that it holds long decreases or the price of a security that it has sold short increases. Losses on short sales arise from increases in the value of the security sold short, and therefore are theoretically unlimited. Because a strategy invests in both long and short equity positions, the strategy has overall exposure to changes in value of equity securities that is far greater than its net asset value. This may magnify gains and losses and increase the volatility of returns. In addition, the use of short sales will increase expenses. Past performance is no guarantee of future results.
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