Several factors support an optimistic view of 2018

Share ThisShare on FacebookTweet about this on TwitterShare on LinkedInShare on Google+Email this to someone

As stocks markets around the globe soared on accelerating corporate profits and strong economic growth, 2017 turned out to be a stellar year for investors.  It was the third best showing for the U.S. stock market since the 2008 financial crisis, with only 2009 and 2013 having higher average returns.  What was different about 2017, though, was that the prodigious stock market returns were, for the first time since 2008, attended by strong underlying economic fundamentals.  Fourth quarter earnings won’t be reported for a few weeks, but based on the first three quarters, together with Wall Street’s best estimates for this quarter, earnings growth for the 500 companies that comprise the S&P 500 are expected to be about 10 percent for the full year.  That would be the best earnings growth we’ve seen since 2011.

During the slow, arduous crawl out of the global recession corporations managed to grow their earnings, primarily, by cutting costs and reorganizing their business models.  But in 2017 businesses finally saw a sustained pickup in demand, both at the consumer level and in business-to-business transactions.  As economic activity accelerated during the year we began to see in the financial press a new phrase that, by December, had become the defining theme of 2017.  That phrase is: synchronized global growth. Europe, Japan, China and emerging market economies such as Brazil, India and the Pacific Rim have all experienced some of the highest GDP rates in a decade, creating a virtuous cycle of growth that has provided an extra boost to the U.S. economy. Consider that somewhere between 30 to 38 percent of revenue generated by the largest corporations in America comes from these foreign countries.

All indications are that this “synchronized global growth” should continue well into 2018.  Indeed, the latest Purchasing Managers Index for Europe showed “robust intakes of new business” that “tested capacity.”  As current capacity gets squeezed, businesses likely will have to invest in new plant and equipment, which would potentially create thousands (and possibly millions) of new jobs worldwide.  These statistics have global banks such as Goldman Sachs and JPMorgan Chase predicting that worldwide growth will be around four percent this coming year, which would be the fastest growth since 2011.  All of this optimism has given currency to another phrase gaining in popularity in financial circles, “rational exuberance.”  Recall that the meteoric rise of stock prices in the 1990s was the result of what then chairman of the Federal Reserve, Alan Greenspan, called irrational exuberance.  But, according to David Kostin, senior analyst at Goldman Sachs, “The current equity market valuation is certainly stretched in historical terms but it does not appear unreasonable based on the high level of corporate profitability.  Thus, the market will experience ‘rational exuberance’ over the next three years, with prices and valuations all supported by earnings growth.”

Another reason for optimism concerning the stock market is the tax bill that was recently signed into law.  Among the reforms written into the bill is a cut in the corporate tax rate from 35 to 21 percent.  The tax savings from this bill will total in the trillions of dollars over the next decade and accrue directly to the bottom line.  With global industrial capacity reaching its current limits, this windfall could not have come at a better time.  Corporations should have plenty of cash on hand to invest in new capacity and innovative technologies that should fuel the next stage of global growth.  Even if this investment fails to materialize, stocks will probably still see a boost as corporate financial officers have indicated that they plan to use the excess cash to buy back stock and pay down debt.

While taxes garnered the bulk of the attention from a policy perspective in 2017, deregulation also looms large as a driver of business optimism here in America.  A new set of figures from the U.S. Chamber of Commerce showed 29 executive actions to reduce regulatory requirements.  In addition, executive-branch agencies have issued 100 directives that either scrap regulations or begin a process to eliminate or shrink them.

With all of this optimism out there, where are the dangers?  According to the Eurasia Group, a New York-based think tank, corporate CEOs see the greatest threat to profits coming from geopolitical risk.

“We see a much greater fragmentation of the global marketplace because governments are becoming more interventionist.  Part of that is because the Chinese have an alternative model for their investments and they’re increasingly going to be seen as the most important driver of other economies around the world who will align themselves more with Beijing than with Washington.”

Other threats listed by the Eurasia Group are the rapid technological developments that are reshaping the economic and political order.  Tensions will increase as countries vie for market dominance and a race for new technologies.  Relations between the U.S. and Iran could be a source of broad geopolitical and market risk.  If the nuclear deal doesn’t survive the year, the Middle East could be pushed into a real crisis.   Finally, protectionism may make further inroads led by populism, state capitalism and heightened geopolitical tensions. “The rise of anti-establishment movements in developed markets has forced policy makers to shift toward a more mercantilist approach to global economic competition and to look as if they’re doing something about lost jobs,” Eurasia said. “Walls are going up.”

Based on the way the stock market shrugged off nuclear tensions between the U.S. and North Korea in 2017, we see these threats as outliers and we expect the U.S. stock market to have another strong year.  Exactly how strong is impossible to say and we are monitoring the markets closely to track any indication of extended volatility.  No one is predicting stocks to repeat the kind of year they had in 2017, but with synchronized global growth set to expand in the coming months we are cautiously optimistic that investors should be able to hold on to the gains they made in 2017 and possibly even gain some more in 2018.


Share ThisShare on FacebookTweet about this on TwitterShare on LinkedInShare on Google+Email this to someone