News headlines concerning political surprises and geopolitical uncertainty, events that have traditionally roiled markets and added volatility, have been generally shrugged off as the upward momentum has continued.
It’s interesting to note how investor focus has changed in the last few years. Not so long ago, markets were characterized by a “risk-on, risk-off” environment driven by daily headlines about matters such as the European Union’s issues and speculation about the direction of the “shadow banking” system in China. More recently, any number of astonishing headlines seems to be overlooked on Wall Street, and the market moves higher. To some, this is taken as indication that investors have returned their focus to financial fundamentals and expectations for improved profitability by corporations in the future. We agree, and think this reflects the recognition by many investors of a synchronized global economic expansion currently underway.
To date, the equity markets have outperformed many analysts’ expectations going into the year. As of December 13th, the S&P 500 was up 21.25% and trading around 2,665 which is significantly higher than even the most bullish analysts’ early-year predictions of 2,500. The rise has been driven by consistently strong earnings results and overall positive economic growth. During 2017, 73% or more of S&P 500 companies beat their respective EPS estimates from Q1 through Q3 and some of the highest earnings growth reported since 2011 while GDP increased at 3.0% and 3.3% (annualized) in Q2 and Q3, respectively.
The general consensus for 2018 is that the bull market in U.S. large-cap stocks will continue, but probably at a more muted pace. We expect high single digit returns from U.S. stocks, with no recession in the foreseeable future. We expect volatility to return to more historical norms (as 2017 volatility was extremely low) with one or more corrections possible at some point during the year.
From a sector perspective, we are continuing to be bullish on Technology, Health Care, and Energy. Technology, a strong late-stage performer, has had a stellar year so far. We see a potential return to capital spending on technology as supporting further appreciation potential well into 2018 and beyond. Health Care has also enjoyed a solid run in 2017 and we believe valuations are still rational heading into 2018, particularly in industry groups that appear poised for further growth. Lastly, Energy, which has been the most hated sector for the last several years, seems poised for a rebound. Earnings growth in Energy has led all others sectors recently, and analysts’ expectations call for that to continue in Q4 2017. We anticipate Energy sector stock prices to catch-up to the Brent Crude rally we saw in 2017, with the prospect of a floor in oil prices around $50.00 per barrel. We also anticipate solid returns from many currently under-valued energy companies in the coming year.
Internationally, we think that attractive opportunities could present themselves as the global economy develops further. In recent months, fund flows have favored developed international markets as relative stock valuations have appeared attractive. In addition, we think that there is opportunity in Emerging Markets (EM). EM stocks have been on a sideways performance track for about the last six years. In a global expansion, this asset class could be poised to provide attractive returns.
One of the major risks we foresee is earnings deceleration. Robust profits in the first three quarters has led to increased expectations. In fact, current forward-looking earnings estimates assume double digit earnings growth over the next 5 quarters (starting Q4 2017). If actual profit results fall short of these expectations, it could be the catalyst for a market correction which we would expect to be in the 5-10% range.
Fixed Income Markets
In the fixed-income area, the Federal Reserve is now established in their strategy of short-term rate hikes and balance sheet unwinding. We’ve experienced three rate hikes during 2017 with the Fed Funds rate starting the year at 0.55% and currently sitting at 1.17% as of December 13, 2017. While the Federal Reserve increased short-term rates, the 10-year Treasury yield remained mostly unchanged, falling slightly from 2.45% in January to 2.36% in December. This flattening yield curve is an interesting factor that we will keep an eye on as 2018 progresses. Meanwhile, returns on credit risk have again been quite attractive this year. Credit spreads have continued to contract (a positive return factor to holders of credit risk) and have reached rather tight levels. At this point, we are more cautious about allocating new assets to credit.
In our model portfolios, we are actively seeking opportunities to make strategic allocation changes and tactical investments to enhance returns. That said, we are wary of making wholesale shifts in allocations in response to short-term market or political events. As one legendary investor once said, “More money has perhaps been lost trying to avoid market downturns, than has been lost in the downturns themselves.” As always, we believe that the path to financial success is to create a rational investment and financial plan based on your own risk parameters, to allow our Portfolio Managers to implement and manage the investment strategy on an ongoing basis, and to stick to your plan through market cycles.
Of course, if you have any questions or concerns, please feel free to contact your Atlas Wealth Management Advisor. They will be happy to discuss your specific situation with you.
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This information is provided by Atlas for general informational purposes only, and is not intended to provide legal, tax, or investment advice. Contact your attorney or other advisor regarding your specific legal, investment, or tax situation.
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