Over the past several years, we have used our year-end Global Market Update as an opportunity to present three key surprises we believe the market does not expect for the upcoming year. Before getting to our 2018 prognostication, we will grade ourselves for last year in which we predicted that 1) Interest rates would not rise significantly during the year, 2) Diversification would regain favor among professional and individual investors, and 3) US foreign relations would improve and help drive global markets higher.
So how did we do? 1) Interest rates as measured by the US 10-year Treasury bond are essentially unchanged for the year; 2) Diversification worked quite well as evidenced by ClearRock’s globally diversified portfolios. The so-called “smart money” such as hedge funds (the HFRI Index) rose at less than half the rate of the S+P 500 this year; 3) While there is plenty of debate about the long-term ramifications of this administration’s relations with many of our allies, markets outside the US rallied, seemingly ignoring politics for now.
Now for our top three surprises for 2018:
#1 – The outperformance of foreign markets continues. 2017 saw a synchronization of global growth for the first time in this business cycle. Low interest rates should continue to boost the recovery in European and Japanese corporate profits. Emerging markets will be an engine of industrial growth for the world. With relatively attractive valuations and leverage to global growth, we believe these stocks will be top performers in 2018.
#2 – The new tax legislation will be great for corporate profits, but could have a more muted impact on growth in 2018. After failing to post any legislation wins for the first 11 months of the year, Republicans passed a controversial tax plan shortly before Christmas. The new plan may not hurt growth in 2018, but we worry about the long-term impact on our national debt and deficit. Some unintended consequences may include higher interest rates, inflation, and trade deficits. Overall, these factors mean that US stocks likely will not achieve the same returns we enjoyed in 2017.
A recent analysis of the Reagan and Bush tax cuts by the Wall Street Journal showed that CBO estimates for Federal revenues and spending both missed their estimated growth targets. The government has a history of collecting less and spending more money than promised. Additionally, most previous tax cuts were passed as the US economy was coming out of a recession. We are well past the recovery phase of this expansion. Instead of accelerating growth from an economic bottom, this plan aims to stimulate an economy that has underperformed despite unprecedented levels of interest rate cuts. There is little precedent for a tax cut occurring this late in a business cycle.
#3 – The new Fed regime will flirt with a policy error by increasing rates too quickly, risking upsetting the smooth seas of global growth. Fed governors are tasked with navigating an oil tanker through treacherous waters where any over-correction has dire consequences. We think a policy error could be a harbinger for the end of this business cycle. The market is forecasting two rate hikes for 2018. Should the Fed exceed two rate hikes, a market correction could ensue as it attempts to digest the latest turns of our economic ship. Jerome Powell will succeed Janet Yellen in February, and this introduces an important, unknown factor into the market.
As Yankee manager Casey Stengel once said, “Never make predictions, especially about the future.” Forecasting the future is not an easy business, but we find that staying diversified, staying invested, and paying attention is a time-tested way to thoughtfully preserve and grow your investment portfolio. We thank you for the confidence you have placed in ClearRock and will strive to earn your trust each and every day.
-The ClearRock Team
Disclaimer: This material has been provided for general informational purposes only and should not be considered as investment advice or as a recommendation. Please contact a ClearRock advisor at 208-726-8858 or email@example.com should you have any questions or would like additional information.