MIDYEAR OUTLOOK 2018
The Plot Thickens
At the beginning of 2018, the handoff in leadership from monetary policy to fiscal policy was well underway as a driver of consumer spending, business investment, and corporate profits, ultimately supporting continued economic growth and stock market gains.
Tax cuts, a more business-friendly regulatory environment, and increased government spending should support consumer spending, business investment, and corporate profits—key drivers of our economic and stock forecasts. The biggest risk to investor confidence this year has been around trade, including new tariffs. When we compare the fiscal measures with the potential impact of increased tariffs, however, the benefits appear to outweigh the costs.
We are starting to see peaks in several economic and market indicators, such as manufacturing growth and earnings, while short-term interest rates are rising faster than long-term rates. However, growth can still be steady after a peak. The context is also critically important here—reaching these points in a positive growth environment is expected and not necessarily a warning sign. So although we are in the later stages of the economic cycle, we don’t see a recession in the near term.
Given that we are in the later stages of this economic cycle, with factors such as increased trade tensions and geopolitical uncertainty at play, we do expect greater volatility in 2018. But it’s important to remember that volatility isn’t defined simply as market declines, and experiencing these ups and downs is a normal aspect of our market environment. If we try to embrace it, instead of fearing it, we have the potential to create opportunities.
Up to 3% U.S. GDP Growth
Early this year we slightly upgraded our gross domestic product (GDP) forecast, as tax cuts should improve personal and business spending. Add the government spending package signed earlier this year and the benefits of increased lending capacity (from recent financial deregulation), and we’re looking at significant fiscal tailwinds. We continue to believe that the combination of these forces will result in GDP growth of up to 3% for the U.S. in 2018.
3.8% International GDP Growth
We believe that the global growth story will continue, with an expectation of 3.8% GDP growth for the world economy, thanks to new fiscal policies and improved business vitality. We continue to expect the U.S. economy to remain a primary driver, aided by the anticipated higher growth trajectory of emerging markets, while international developed markets may lag. Primary risks to our global and U.S. economic forecasts include an unexpected rise in inflation, a substantial increase in trade friction, or a policy mistake.
We expect returns of 10% or higher for the S&P 500 Index (including dividends), with earnings growth the primary driver. The S&P 500 may be well positioned to generate mid-teens or better earnings growth in 2018 thanks to a combination of steady economic growth and better corporate profits, thanks to the new tax law. Although we do expect volatility to increase, in the context of steady economic growth and strong corporate profits, we see the potential for further stock gains in the second half of 2018. Risks to our stock market forecast include potential negative impacts on companies’ profit margins due to wage increases, geopolitical risks and trade tensions, and political uncertainty around the midterm elections.
Flat-to-Low, Single-Digit Returns
As expected, accelerating global growth and rising interest rates continue to pressure bonds. We maintain our forecast of flat to low-single-digit returns for the Bloomberg Barclays U.S. Aggregate Bond Index. However, we want to emphasize that fixed income continues to play an important role in a diversified portfolio. Bonds can provide income and liquidity, and may serve to help manage portfolio volatility during periods of stock market turbulence. We continue to position portfolios with below-benchmark (Bloomberg Barclays Aggregate) interest rate risk, preferring to take credit risk in the current environment.