2018: The Road Ahead

2018 Market Drivers

Coming off one of the most unpredictable years in memory, we take a look a the year ahead and identify what we see as the likely primary market drivers.

Economic Fundamentals Strong

• Corporate profitability has been rising, and indicators, such as the Manufacturing PMI, point to continued economic strength in 2018.

Tax Reform Put Into Practice

• It is well understood that corporate earnings will be higher this year due to the lower corporate tax rate.
• In addition, we expect to see, 1) increased repatriation of overseas cash, driving a rise in M&A and share buybacks, and 2) a boost in capital spending, particularly in Industrials as they take advantage of accelerated expensing under the new tax law.

Political Uncertainty Rises

• In 2017, stocks largely ignored the Washington drama, preferring to focus on potential corporate-friendly wins like tax reform and deregulation instead.
• The mid-term elections have the potential to change that. A strong Democrat rebound could put a damper on the GOP agenda. However, gridlock has historically not been viewed negatively by equities.

An Active Federal Reserve

• The Fed continues to be an important factor as they try to refill their economic toolkit, moderate growth, and deal with a flattening yield curve.
• It will be a test for the new chairman, Powell, who takes over the reins in February.

Market Predictions

500 Strong

• Another 15% upside from the S&P 500 is in the cards this year.
• The big question is how much of the market drivers above are reflected in stocks? With Bloomberg consensus estimates calling for a near 24% increase in earnings for 2018, we see few potential headwinds for stocks until the mid-term elections.

Value Line

• While Growth stocks had their year in 2017, we expect fundamentals to drive returns for stocks in 2018, favoring Value.
• Cash repatriation should benefit profitable multi-national companies more so than those with little-to-no current earnings.

Size-Wise

• We see Small Cap stocks grabbing the lead from Large Cap in 2018.
• Smaller companies tend to be domestic focused and should see a greater benefit from a lower tax rate, increased M&A activity and a stronger economy.

Still Emerging

• After an extremely strong 2017, we should hesitate to predict that Emerging Markets will have another year of besting Developed Markets, but it is hard to argue with expected growth.
• The Organization for Economic Co-Operation and Development (OECD) projects real GDP growth of over 6.5% for emerging economies such a China and India in 2018, compared to 3.7% globally.

Interest in Interest

• With the U.S. already on a tightening path, we expect a less accommodative stance on interest rates from the rest of the world.
• The Fed will raise short rates at least three times in 2018, but we will need the rest of the world to join us or some non-traditional maneuver by the Fed to steepen the yield curve.