Accounting On Us
2018 Economic outlook
Markets, taxes, economic growth + more
Michael Carlin, AIF
2017 marked another great year of performance for the stock market. Investors started to pile in from all walks of life and for the first time in many years, the stock market seems to be on the lips of everyone from conversations at your barber shop to your Uber ride. As soon as people find out that I manage money for a living, they’re quick to ask what do you think the market is going to do this year? Are we going to see continued rallies? Do you think that the Trump presidency can keep the economy moving forward? Of course, by far, the most popular question is how much Bitcoin should I own? We’re going to tackle these questions and others over the next few paragraphs.
Last year the stock market, as measured by the S&P 500 (the largest 500 big-size companies in the United States), was up 21.8%. Even the unstable and unpredictable emerging markets were up over 37% last year alone. In fact, you could look across the broad spectrum of bonds and see, like stocks, they also had an outstanding year of performance. But, the process of making money is not as simple as looking at what has performed well and assuming it will continue to perform well in the years ahead. Instead, we need to look at the economic fundamentals to help us decide how stable our economy is and what our likelihood of continued performance might be.
U.S. economic growth
Analyst research that we follow varies widely, but we have commonly seen expectations of U.S. economic growth greater than 3% this year from many Wall Street institutions. Should that indeed happen, it is reasonable to believe the stock market would react favorably with that kind of economic growth, lifting everyone’s economic tide higher. Keep in mind, U.S. economic growth unexpectedly slowed in the fourth quarter of 2017. The economy grew 2.3% in 2017, an acceleration from the 1.5% logged in 2016. The market did well on 2.3% growth, and if we could get 3% or better, good things may happen with stocks.
Watching the Federal Reserve
In 2018, many anticipate the Federal Reserve will have four interest rate increases. Here’s the good news if that does happen: if the Federal Reserve believes the U.S. economy can handle higher interest rates, and the economic data keeps coming in strong – the Fed may keep moving rates higher. Yet, understand that at some point, all those interest rate increases typically have an effect of slowing down the economy to such a degree that Wall Street starts to view economic good news as potentially bad news, leading to further rate increases. This “good news is bad news” scenario happens on Wall Street occasionally, and we may see this take shape at some point later in the year.
Big picture with interest rates: our interest rates are still historically very low at current levels. These low rates help provide a good foundation for economic growth. Maybe that will change as the Fed increases rates, but for now, low rates help support our growth.
Consumer confidence continues to be strong. According to the NFIB survey, sentiment for small business owners is also historically quite high. In fact, we’re seeing confidence numbers for consumers and businesses at levels we haven’t seen this decade. Confidence typically means more spending, and more spending by businesses and consumers normally translates into more growth. We are watching the confidence numbers carefully in the event they slip or change trend.
According to the Federal Reserve Report Survey of Consumer Finances, we are seeing middle class wages beginning to recover on a real basis. We like this because the more consumers have in their pockets, the more they will be able to spend and drive economic activity. At some point, continued wage increases could do harm to company profits. But for now, we don’t see that on the immediate horizon.
Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act is slated to help companies become more profitable while reducing individual taxes on many (but not all) households. One would expect when we get fiscal stimulus from Capitol Hill that it translates into good stock market performance. We hope that is the case moving forward.
Okay, if you’re like most other clients, you’re wondering what to do about Bitcoin. In our opinion, we think that the blockchain technology is a force to be reckoned with long-term. But, we also know from historical data that some of the most spectacular crashes in world history are destined to repeat themselves. Ever heard of the Dutch tulip disaster of the 1600s? In 1637, tulip traders paid massively inflated prices for tulips, leading to worldwide speculative pricing and a price chart for tulips that looks a lot like Bitcoin! When the collapse happened in tulip prices, it occurred quickly. From February to May of 1637, the price of Tulips dropped. In fact, prices dropped for tulips more than 90% over a very short period of time, and even 100 years later, the prices were still 1/10th of those high-water mark prices set during the days of flower speculation (source: www.steemit.com ). We aren’t comparing tulips to Bitcoin necessarily, but we can’t rule out the similarities in both situations.
Stock market performance + your future
With all this positive economic news we just discussed, does it translate into market performance? Right now, in our opinion, those positive economic forces bode well for the stock market. Despite all that good news, we do need to address that it’s been a long time since we’ve had a correction or market pullback. Here are some numbers for you to consider (source: CMO Alliance Bernstein):
- The typical number of weeks between 5% downward corrections in the stock market since 1928 is 10 weeks. At the time of this writing, it has been 77 weeks since we’ve had such a correction.
- Similarly, we have a 10% downward correction usually every 33 weeks. Yet, it’s been 96 weeks since we’ve had one.
- Lastly, we have a 20% downward correction every 127 weeks, but we haven’t had one in 445 weeks.
All this data should make you a little concerned. As a result, by many measures, both stocks and bonds do appear to be expensive when looking at CAPE Ratios in the spread between BAA and AAA bonds.
Our advice here would be to reevaluate your portfolio holdings and understand your portfolio risk! In lots of cases, investors get a false sense of bravado because their portfolio performance has been outstanding recently. This is an ideal time to think about taking profits and finding areas of the market that are undervalued. Stated otherwise, as great as things appear to look on paper, we would consider this the perfect opportunity to find the right balance in your portfolio for an economically stable but growingly tense stock market environment.
For a more in-depth look at our first quarter expectations, check out our all new Manage the Funds podcast. If you have questions or would like to discuss these topics, be sure to contact Henry+Horne Wealth Management.