Global Markets: Optimistic
International investments were near the top of performers as predicted for 2018. While the Dow and the Nasdaq inched ahead of the MSCI EAFE ex-US, the performance in the international markets still appears to have more room to run. Investors are seeing unemployment continuing to trend downward not just in Europe but all around the world. This should lead to a healthy amount of inflation in prices in developed markets, allowing earnings to lift. Manufacturing demand has sustained all around the world, which should drive another year of good earnings in 2018. Political risks seems to have shifted if only temporarily to Asia and the Middle East, allowing confidence to rise and nerves to settle in Europe. Brexit also appears to be less impactful than originally anticipated, allowing Europe and her trading partners to sigh in relief.
U.S. Economy – Very Good
The US Economy has persisted in posting stronger and stronger results, especially in the area of unemployment. Talk is now turning toward what unemployment in the 3.5% range could do to limit productivity, demand, and growth. Interest rates remain low, and inflation has held at very low levels. Despite dropping unemployment, rising rates, slightly rising energy costs, and a weakening dollar, inflation stays stubbornly low. The biggest risk to the economy continues to be political risk. While the tax bill will create a short term stimulus to the US Economy, the behavior of Washington could slow, or even derail, the pace of economic growth. In addition, with this long stretch of growth behind us, growth could continue to be healthy, and at the same time slow just from maturity in this economic cycle.
Inflation – Good Projected to Stay Low
Inflation has stayed remarkably low despite every factor that affects it moving to raise it. Energy prices and continued wage inflation, along with rising demand from a richer consumer might push it up. No signs point to acutely rising inflation at this point.
Interest Rates – Good with caution
It is expected that the Fed will fulfill their projection to raise rates 3 or more times in 2018. A change in the Fed Chair does not change this vector. There remains a commitment to shrink the balance sheet, and raise rates in order to regain the ability to react to negative economic conditions in the future. Investors should remain cautious, despite the interest rate path visibility, as values could move down in vulnerable areas as these adjustments occur.
U.S. Stock Market – Good with Caution
2017 was a year of performance very few investors expected. There was synchronous global growth in almost all markets, with the S&P and Dow both posting growth at nearly 30%. 2018 is the 9th year of a bull market and economic expansion. There are no real signs that this is ready to reverse, except that it is likely that earnings growth could slow in 2019 as the impact of tax stimulus is played out which the market may begin to anticipate as these results come more into focus toward the end of the year. Multiples are also a bit high, at a little over 18.2 times earnings, which could seem very rich of prospects for growth deteriorate in the future. It is also worth noting that the US stock market performance in 2017 was dominated by a very small group of stocks, which might push some cautious investors to rotate from aggressive growth to more value oriented and certainly more diversified portfolios. Because the world is expecting that at some point the party must come to an end, it is possible if not likely that any negative news about economic and market prospects could result in an overreaction to the downside.
Recent allocation changes have yielded good results in 2017. A greater exposure to International Equities turned out to be timely. There is still room for normalizing this allocation if you have not done so yet. Value oriented portfolios may have posted good numbers in 2017, but underperformed the indices they track. Investors should not despair, as over the long run this style tends to self-correct. In 2018, make sure to have a balance of Growth and Value in US Equities. Stay focused on your discipline, and rebalance on a regular basis. It is more important than ever to maintain the correct risk exposure, and exercise an optimistic but cautious approach.