2017 has been a banner year for stocks. The next question becomes, can stocks keep going up in 2018? The consensus among analysts is yes, but not to expect a repeat of this year’s performance.
Stronger-than-expected economic growth has helped companies deliver on earnings, which have powered impressive returns in the stock market, says Turnill. This narrative remains mostly valid for 2018; however, economists expect advanced economies to grow more slowly in the coming year.
The world economy has never been in better shape, according to Deutsche Bank’s chief international economist Torsten Slok, who notes that this is a time in which the fewest countries are in a recession. While stocks don’t necessarily move in lockstep with the economy, the macro picture looks rosy for more stock market gains.
Low volatility underscores the conviction among investors that the current environment of modest growth and tepid inflation is here to stay, according to Vanguard’s outlook for 2018.
The wildcard is U.S. tax reform, which is gradually getting priced in by markets. J.P. Morgan anticipates a bump of US$10 to S&P 500 earnings. The investment bank also has one of the highest 2018 year-end forecasts for the index, at 3,000—roughly a 12 percent gain over the next year.
One of the benefits of corporate tax cuts is companies using the added funds to invest in their businesses. Business investment hasn’t climbed in line with the economic recovery, but Vanguard thinks capital investment will play catch-up in 2018.
“This is the stage of the [business] cycle where we see the fastest pace of business capital investment,” according to Vanguard.
Inflation at Last?The synchronized global recovery narrative really took hold in 2017, and more major central banks joined the U.S. Federal Reserve in raising rates. The Bank of Canada raised rates twice and the Bank of England raised rates for the first time in 10 years in 2017.
“What’s different now compared to the past five years? The answer is that with stronger global growth, economies are reaching full capacity, and that is by definition when inflation pressures begin to appear and hence when central banks begin to exit [accommodative policy],” said Slok in an email to clients.
Inflation has been slow to react to the improvement in labor markets and economic growth, but many feel that 2018 is the year this will change. Markets still have their doubts about inflation as advanced economies haven’t had to deal with consumer price inflation since the 1990s.
Few Risks to the OutlookDespite better-than-expected economic growth, low inflation was one factor holding longer-term bond yields little changed in 2017. This, along with rising short-term yields from central bank rate hikes, led to flatter yield curves in the United States and Canada. Given the flattening of yield curves, some chatter is arising about the next recession as a threat to stock market gains.
Slok also points out that it’s not Fed tightening that typically causes recessions. He noted that another important indicator is the widening of high-yield bond spreads. This was one of the precursors that signalled the last two recessions (2001 to 2002 and 2008 to 2009), and these spreads remain contained.
However, the risk factor that materializes and sends the market for a correction can be something unforeseen.
What can be foreseen is the threat of NAFTA unravelling. This would likely necessitate a repricing in North American financial markets, unlike how geopolitical flare-ups have been summarily dismissed in 2017. In fact, the S&P 500 never even saw a 3 percent drop this year, according to BMO.
The story looks to be that equities again remain the place to be, for the time being. They certainly have a better case going for them than bonds do.