The Road Goes on Forever

The start to 2018 means one thing for us—prediction time is here.  Once again, we are excited about the opportunity to completely whiff (note the humor!) on several themes we believe may play out over the course of the 2018 investment year.  As many of you know, this is an annual “event” for us at Stone Bridge, and we do love our traditions.

Let’s recap our three predictions from 2017:  1) US equity markets break the trend of negative returns during the first year of a new US Presidential Term and finish positive.  Massive understatement with this one.  Markets hit all-time highs, market volatility hit and remains near historical lows, and this is the longest period in the history of markets without so much as a 3% correction.  2)  Emerging market stocks have solid performance.  This was another understatement. EM stocks were one of the top performing asset classes for 2017.  3)  The Federal Reserve raises rates twice in 2017.  We missed this one.  Global synchronous growth gave the Fed confidence to push rates higher three separate times in 2017.   It seems that while we were very positive for the 2017 investment climate, we did not anticipate or even consider the possibility of historical returns. 

So, as we cruise on down the economic highway with 2017 in the rearview mirror we can faintly hear the lyrics of Robert Earl Keen’s song drifting from the radio, “…the road goes on forever and the party never ends.”  If the first few trading days of 2018 have anything to say about how 2018 turns out, they would want us to believe that the party is still going strong. 

Here are our predictions for 2018:

1)    Continued market strength for Q1 and Q2 fueled by synchronous global growth, accommodative monetary policy from Japan and Europe, and strong US corporate earnings benefitting from both global growth and the newly minted tax reform.  Only the threat of wage inflation and an inverted yield curve sometime near the 3rd quarter will give the market a reason for concern (and we stress threat, not actual occurrence).  We think this might be cause for a pullback in the second half of the year, but not a recession.

2)    Geopolitical risks shift from North Korea and missile testing to trade reform and NAFTA negotiations, Brexit issues and Syrian and Libyan refugees in Western Europe.  These are potentially the real risks to the continuation of the global economic growth story in 2018.  On the home front our mid-term elections will also do their fair share to contribute to mid-year market volatility. 

3)    The Fed says three interest rate moves and we finally take it at its word.  We don’t expect any shift in current Fed policies as Jay Powell takes over as Chairman from Janet Yellen.  With the markets continuing to push to higher highs, the Fed effectively has a free pass to continue on its path of measured interest rate hikes.  We will be looking for the Fed to announce 0.25% increases at the March and June meetings, followed by a pause during the Summer, and then for it to deliver one more 0.25% hike in December.  Powell and the other Fed governors will be keeping a close eye on the shape of the yield curve (as we discussed last month). 

4)    We all will know what a BITCOIN is by the end of 2018.  More importantly, we will begin to understand the value of blockchain.

We realize that we are a little more granular than previous guesstimates (combination of guess and estimates), but we do believe that conditions and sentiment warrant the details.  While we are currently enjoying the economic “drive” and want to stay on this “road” for as long as we can, we firmly have two hands on the steering wheel looking out for possible “pot holes”.  We continue to remain positive for many reasons.  The economic fundamentals are strong and market technical indicators are currently pointing to positive territory.  However, most investors are not asking what areas of opportunity are out there, but instead are asking the more conservative question of when this “party” will end.  Ironically, this is a bullish indicator.