We head into 2018 with significant economic tailwinds, improving estimates for corporate profitability, and expectations for additional economic expansion. That said, I suspect the hunt for equity market ROI this year may be a bit more challenging than it was in 2017.
Much of the run-up in prices that we saw in 2017 was predicated on what was expected from the Trump administration. That has been priced into equity markets, and though the tide and equity prices will continue to rise, valuations are currently stretched. I suspect we see a modest shift in rotation out of US equities into less expensive global markets. A degree of that focus will be into the emerging space with a concentration on Asia and Africa. Europe will also be more in vogue than in recent years.
My 2018 year-end targets and projections
US GDP: 3.3%
US Unemployment Rate: 3.9% (Full Employment)
US 10-year yield: 3.15%
Federal Reserve Inflation targets (2.0%) achieved
Gold: 1,485/t oz
WTI Crude Oil: $65/bbl
Dow Industrials: 27,932
S&P 500: 2993
With the passage of the tax bill in December, expect the US manufacturing sector to pick up additional momentum in 2018. Lower corporate tax rates (nominally from 35% to 21%) will likely encourage global manufacturers to relocate to the US. It will also act to encourage US manufacturers to invest in their domestic footprint and in technology to further automate production and increase efficiency. As a result, employment growth in the manufacturing sector, though likely to be muted, is expected to remain constructive.
Military engagement with North Korea
Hotter than expected inflation in the US
Middle East violence/unrest
Political turmoil in Iran
Impeachment efforts by either the Democrat party and/or the President’s cabinet gaining momentum
Unexpected mid-year political theatrics
If there is a theme that could bring this equity market rally to a halt, it is not currently evident. As I have pointed out in recent notes, earnings estimates are once again on the rise for the S&P 500, economic data is providing a solid underpinning to markets, and global economic expansion is not only on track but seemingly well synchronized. In addition, the Trump tax code legislation appears to be lifting expectation for further earnings growth and economic expansion.
A subdued Volatility Index (VIX) and extended equity valuations are worth watching closely, but the US Treasury yield curve has not inverted and is not likely to in coming quarters. I expect the VIX may remain subdued and that corporate earnings will support equity valuations. Ultimately the US Treasury yield curve will once again widen. Honestly, I would like to make a counter-argument but intellectually I just don’t see it – yet.
Happy New Year,
Peter C. Kenny