We’ve long maintained that making specific predictions regarding the markets are pointless at best and dangerous at worst. As evidence feel free to refer to almost anyone’s predictions from years prior. In some cases, the predictions are laughable in their complete divorce from reality. Of course, it’s easy to see the absurdity with the benefits of hindsight. And, yes, admittedly some predictions, even ones that are oddly specific do end up coming true exactly as predicted – but then again someone picks the Powerball numbers eventually too. Good luck knowing who it’s going to be ahead of time! I guess the point being someone is bound to be correct eventually when there are enough people prognosticating such things.
What we do know is that there are some factors that will most likely dictate what happens in markets Those we can cover here with a reasonable degree of certainty. There are also those factors that are unknown and unknowable. Those, obviously will not be covered. While we find the exercise of making specific predictions worthless, having an outlook that takes into consideration the factors we think are most likely to impact markets is not only valuable, but we feel, critical in terms of being able to create an investing framework for the year ahead.
With that said, an outlook is a guideline, a fluid one at that, and one subject to change for any number of reasons, or for seemingly no reason at all for that matter. Please keep this in mind when reading and proceed cautiously into the great unknown of the year ahead.
Also, we’d like to caution that while we have an outlook for the year ahead we are not the type of firm that makes changes on such a short term, tactical basis. We’ve found through experience, that those who do so are more likely to be wrong than they are right, and even when right the investment changes made (or not made) are often either not additive outright, or certainly not worth the effort in terms of trading and tax costs when all is said and done.
Here is what we’re pretty sure we know.
There is going to be a new head of the Federal Reserve. Jerome Powell will be taking over for Janet Yellen. Despite the change, actual Fed policy is unlikely to be altered whatsoever. At the most recent Federal Reserve meeting, Chairman Yellen indicated that the Fed’s policy of interest rate hikes is likely to continue in 2018. This is not expected to change under a Chairman Powell Federal Reserve, especially because Mr. Powell is expected to lean heavily on the Fed’s board of governors, as all Fed chairmen do, and perhaps even more so because he lacks some of the economic bona fides of many of his immediate predecessors.
The Federal Reserve has a dual mandate: to keep inflation in check within a desirable range and to keep the unemployment rate low. The unemployment rate at this point remains quite low and inflation is in line with Federal Reserve targets. Both factors are subject to change with shifting economic conditions. While the market is now expecting, and therefore pricing in rate hikes for the remainder of 2018, a severely weakening economy could theoretically put that strategy on hold. To be clear, we’re not seeing a drastically weakening economy in 2018, but then again such things do not generally announce themselves ahead of time.
While we don’t see the economy taking a dive, we do have to acknowledge that we are deep into the recovery from the great recession. And, yes the initial recovery was slow, I think it’s safe to characterize this pace as having picked up somewhat over the years, though still far from what might be considered so hot that the Fed is faced to raise rates quickly and in large increments. While we don’t see drastic moves forward or backward for the economy a bit of a lateral shuffle or even small steps either forward or backwards are more likely.
There is a tailwind at the back of earnings, which is ultimately what drives the market on a fundamental basis. A rising market in turn drives consumer confidence, spending and investing, in turn further driving markets higher – a virtuous cycle of sorts. In such cases it is possible that the good times tend to cause some over indulgence in the markets, spurring a hangover of sorts which causes markets to drop, sometimes quickly, while a new balance is struck. We feel this is a real possibility this year, if for no other reason than the winning streak has been so long and largely uninterrupted at that, that a decline, even a modest one, seems to be a likelihood as some investors take profits off the table.
Another factor that bodes well for continued economic expansion and therefore continued market gains are the recent, mainly corporate, tax cuts. These cuts will allow consumers, and more importantly, companies to save on their tax bills, freeing up money to invest in infrastructure, growth or even their employees. Continued cuts in regulation are also a positive for the markets, though arguably they cause other lasting damage, whether it be environmental or otherwise.
Let’s not forget that while things in the US seem rosy economically, if not politically. The economy is a global beast. Most of the S&P500 constituent company’s revenue now comes from overseas, not the United States. It is likely that any drop off in Asia or Europe would have some effect on domestic markets, though how much is impossible to state with any degree of accuracy.
Speaking of the political situation in the United States, it does pose a risk to continued market growth. Mid-term elections are already coming up this year and a shift in power could spook the markets into losses. Markets are agnostic as to Republicans or Democrats, but they do like certainty more than anything. A shift from a Republican controlled legislature could signal possible changes to the business community, which in turn could trigger losses while markets try to make sense of what is likely to happen and what, if any, impact it will have on individual firms.
War, of course, also is a very real possibility, with North Korea flexing its atomic muscles more than ever before and now seemingly being able to back up that bluster where before it was a known bluff. Do we think war is likely, no. In the even to war it wouldn’t be much of a competition given the North Korean military is vastly outgunned in every facet of the game. Their only home would be a Vietnam style guerrilla war, which hopefully the US is smart to avoid. With that said, any credible threats, and certainly any aggressive actions against the US or South Korea would be likely to cause markets to dip sharply.
2018 is unique in so far as every year is unique. We enter each year with some idea of what’s happening based on longer term trends and expected changes and there are always factors that come into play that no one expects. Our advice for 2018 is that same as it has been in years prior: stay invested but do so in a portfolio that is right for you. The right portfolio is one that doesn’t get you too excited about gains and certainly doesn’t make you panic with losses. Having a plan and staying true to the plan are the two most important factors that will ultimately determine your long-term success of failure as an investor, regardless of short term market or economic conditions.