HIGHLIGHTS
• Improving global economic growth and solid corporate earnings should drive equity markets higher in 2018.
• Geopolitical issues present risks, but the largest negative may be a rise in inflation.
• Overall, we expect 2018 to be good for stock markets, but with higher volatility and lower returns compared to 2017.
U.S. stock markets rose sharply thanks to optimism over global economic growth and corporate earnings. These factors were the primary drivers of equity returns last year, and we expect they will continue as important trends in 2018. Last week, investors focused on the positives associated with the recently passed tax package and hopes for further corporate deregulation. The S&P 500 Index rose 2.6% for the week, with technology and commodities-related companies performing particularly well.1 In contrast, utilities and REITs fared the worst and were down more than 2%. In other markets, gold prices gained 1% and oil prices rose for a third straight week.1
Weekly Top Themes
1. Despite disappointing headline numbers, the labor market remains strong. December’s jobs report showed a less-than-expected 148,000 new jobs created.2 That number, however, is still higher than the 75,000 to 100,000 range the Federal Reserve indicated is necessary for the unemployment rate to remain steady.2 Additionally, the three-month average of new jobs is still more than 200,000.2 The report also showed that wage rates rose only slightly by 2.5%.2
2. Manufacturing remains a bright spot for the U.S. and global economies. The Institute for Supply Management’s manufacturing index rose to 59.7 in December, a three-month high.3 For all of 2017, the index was at its highest average level in 13 years.3 Earlier in the week, we also saw a batch of strong manufacturing results from around the world.
3. Tax cuts are likely to boost economic growth, but they will also likely cause higher inflation. Wages in particular may be ripe for an increase. As a point of reference, the current tax cut is being enacted at a time when unemployment is just over 4%.4 This compares to an average of 7% unemployment for the past seven major tax cuts.4
4. Tax cuts are likely to cause confusion for fourth quarter corporate earnings results. First of all, companies will be required to record the full tax assessment of international earnings as a charge. Additionally, investors will have several key questions about future guidance: How will companies incorporate tax changes into their forecasts? Will they plan to allow benefits to flow into future earnings or will they focus on reinvestment?
5. Investor sentiment appears to be improving, but skepticism remains. From our observations and discussions with investors, it seems that while market sentiment is better than it was a year ago, investors are still cautious.
So far, investors seem comfortable ignoring political drama
The year began with a sense of political turmoil coming from Washington. The news included President Trump’s latest confrontation with North Korea, a feud between the president and his former strategist Steve Bannon, worries about more restrictive trade measures and struggles to secure a bipartisan deal in the Senate over immigration reform.