While the market was up nearly 22% for 2017, around 20% of the S&P 500 companies ended lower for the year. We believe this speaks volumes as to why investors should have a well-diversified portfolio. Forecasting is a nearly impossible task, and while we don’t focus too heavily on predictions, we do have some insight as to what 2018 may bring.
Broadly speaking, market pundits’ and analysts’ outlook range between 3%–16%, each citing various reasons. The piece to note is that nobody is calling for a negative year in 2018. Sentiment is still strong in the market, and earnings have been supportive of companies’ valuations. However, the market is expensive trading at a 36% premium to the long-term price-to-earnings ratio (P/E) average of 16.5. The S&P companies are currently trading at 23 times earnings. This leads us to think we may see a lower-than-average return for 2018. The long-term average annual S&P return is still around 10.5%, but we expect something around 6% to 7% in the year ahead. We do not expect the wheels to come off the economy, but the reasoning for our forecast is that prices are already high.
We believe the regulatory changes are already built into the price. Even sweeping tax reform didn’t really move the market. We suspect it will take real action for the markets to move further. The repatriation of funds and capital expenditure increases may have the potential to spark movement again.
The concern on the table is inflation, and we’ve already seen the Federal Reserve slowly raising rates despite the economy registering less than 2% inflation. Looking ahead, the Fed has forecasted three interest rate hikes in 2018. Economic growth drives inflation and inflation drives the Fed to react. 2017’s rate hikes may be steps by the Fed to get ahead of inflation.
The next step is to try to determine where we are in the economic business cycle. As we stated, sentiment is still strong, prices are high, and volatility is at a low. We’ve also seen a flattening of the yield curve, where the shorter- and longer-term yields are very close to each other. This can be a predictor of an economic transition. We are likely experiencing late cycle expansion. The next step is usually the end of the cycle, including a slowdown which can be followed by a recession. In this stage, being defensive with your portfolio allocation can be a good move. However, we do not expect to see a recession in the next 12 months.
For 2018, we like Healthcare, Consumer Staples, and Energy; however, Energy is nearly impossible to predict because crude oil is a managed commodity. We are also interested to see how Communication Services fares in the new year. The S&P Dow Jones Indices and MSCI Inc. announced that the Telecommunications sector will be broadened and renamed to Communication Services. The new sector will include existing telecom companies but will also be absorbing companies from Consumer Discretionary and Information Technology. We also expect to see many of the high flyers from 2017 normalize in price.
While market forecasting is nearly impossible, we believe investors should still be aware of where the economy is in the economic cycle to help prepare for the year ahead. If you have questions regarding your positioning for 2018, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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