Investment Outlook

Ten predictions for 2018: 2Q update
Stocks stuck in the crosscurrents

Robert C. Doll, CFA
Senior Portfolio Manager / Chief Equity Strategist,  Nuveen Asset Management
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Key points
  • Q1 in review: The U.S. economy is accelerating, but trade issues present a growing risk.
  • A look ahead: At the halfway point of the year, most of our predictions are trending in the right direction.
  • Key themes for investors: Volatility is likely to remain high relative to last year and security selection will remain critical.

Our overall theme for the year has been that we expect 2018 to be “less perfect” than 2017. We see continued decent economic growth and corporate earnings, as well as low but rising inflation and yields. At the halfway point of 2018, the year is mostly shaping up as we expected.

Ten predictions for 2018

Prediction 1

U.S. real GDP reaches 3% and nominal GDP 5% for the first time in over a decade. 

First quarter economic growth came in at a relatively slow 2.2%, but current expectations are for second quarter growth to be close to 4%.1 We expect growth to rebound and accelerate, especially given the strength in the labor market, a tailwind from additional fiscal stimulus and rising capital expenditures. With inflation climbing modestly, we also believe nominal growth should climb.

 

Prediction 2

Despite ongoing protectionism, the global expansion continues with the fewest countries in recession in history.

Rising trade protectionism remains a threat to the global economy, and has increased in recent weeks. So far, however, the world economy has looked past these issues. While growth in some parts of the world may be slowing, the overall world economy remains in very good shape.

 

Prediction 3

Unemployment falls to the lowest level in nearly 50 years as wage growth is the highest since the Great Recession.

The first half of this prediction has come to pass, as unemployment is down to 3.75%, matching its lowest rate in 50 years.2 Wage growth has slowly risen from 2.5% to 2.7% this year, and we expect it will get to 3% by the end of 2018.2

 

Prediction 4

The yield curve flattens (but does not invert) as the 10-year Treasury yield reaches 3% for the first time since 2014.

Bond yields remain surprisingly low, yet the yield on the 10-year Treasury crossed the 3% mark earlier this year and peaked at 3.11% on 17 May.3 The spread between the 2-year and 10-year Treasury yield narrowed from 52 basis points to 33 by the end of the second quarter.3 We expect both modest flattening of the yield curve and unevenly rising yields to continue.

 

Prediction 5

Stocks enjoy longest bull market in history but experience a 5+% correction after the longest period without one.

The second half of this prediction already happened in February when stocks experienced their first significant correction since 2016.3 Should equity markets make it to August 22 this year without the bull market ending, the first half of this prediction will come true as well.4

In this environment, we prefer companies with domestically sourced earnings and those with the ability to utilize high levels of free cash flow.”

 

Prediction 6

U.S. equity returns lag earnings growth for the first time in six years, the longest streak in decades.

So far, this prediction is probably our “most correct” of the year, since earnings growth has been amazingly strong while stock prices have advanced only modestly. Estimated 2018 earnings-per-share growth for S&P 500 companies stands at 20.1% year over year, while the S&P 500 Index has returned 2.7%.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.

 

Prediction 7

Equities beat bonds for the seventh consecutive year for the first time in nearly a century.

As of the end the second quarter, the S&P 500 Index was up 2.7%, while the Bloomberg Barclays U.S. Aggregate Bond Index was down 1.6%.3 We expect both markets to remain volatile over the next six months, but given the economic growth, earnings and inflation backdrop, we think this prediction is likely to remain correct.

 

Prediction 8

Corporate capital expenditures increase at the expense of share buybacks.

Capital expenditure levels are picking up, which is boosting productivity and should help continue the economic expansion. As of May, the Institute for Supply Management is forecasting capex spending will be up an incredible 10.1% in 2018.5 Share buybacks have also increased, however, which makes this prediction a bit muddled. Should capex levels continue to pick up, we may be able to mark this one correct by the end of the year.

 

Prediction 9

Telecommunication services, information technology and health care outperform utilities, energy and materials.

This prediction is barely trending in the right direction so far. A basket of our most-favored sectors is up a bit more than 1.4%, while a basket of our least-favored is trailing at just under 1.4% at the halfway point of the year.3 Assuming economic growth continues to improve, we think this prediction should be correct by the end of the year.

 

Prediction 10

Republicans lose the House, retain the Senate and further distance themselves from President Trump.

Political futures are about as volatile as equity markets, and five months can be a lifetime for politics. Absent a significant shift in the political landscape, however, we expect Democrats will be able to take the House of Representatives in November, although the Senate is less likely to see a leadership change. Many Republicans have been distancing themselves from the president, with the latest divide coming from President Trump’s immigration policies.

 

Video | Bob Doll Market Update: June 2018
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Sources
1 Bureau of Labor Statistics
2 Commerce and Labor Departments
3 Bloomberg, FactSet and Morningstar Direct
4 Bank of America Merrill Lynch Research
5 Institute of Supply Management and Cornerstone Macro Research

The S&P 500® Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. The Russell 2000® Index measures the performance of approximately 2,000 small cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. Euro Stoxx 50 is an index of 50 of the largest and most liquid stocks of companies in the eurozone. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of a selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The MSCI World Index ex-U.S. is a free-float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed markets minus the United States. The MSCI Emerging Markets Index is a free-float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Bloomberg Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income. The Russell 1000® Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values. The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

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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