Wall Street eyes 2018 gains with a side of caution
US stocks are expected to keep rising in 2018 because a massive drop in the corporate tax rate is seen boosting the economy and corporate profits. But strategists say sizable gains could either be short lived or elusive.
The bull market is on track to mark its ninth birthday in March, with the S&P 500 climbing 20% for 2017 – its biggest increase since 2013. The drop in the corporate tax rate in 2018, to 21% from 35%, is seen by many as the biggest factor for the stock market this year.
Yet 2018 share gains are expected to be smaller than 2017, with the S&P 500’s price/earnings ratio – a measure of stock prices against expected profits – is around its highest level since June 2002. Many on Wall Street cite potential pitfalls, even though they see no signs of a recession.
“We’ve had six years in a row where stocks have [outperformed] earnings, and I think we break that streak with stocks going up but not as much as earnings,” said Robert Doll, the chief equity strategist at Nuveen Asset Management in Princeton, New Jersey.
Some say the tax bill’s benefit will be short lived. J.P. Morgan Asset Management chief global strategist David Kelly described the bill as “more carbs and less protein,” because the tax overhaul will improve spending but does nothing to boost productivity.
“It’ll be a one-year wonder,” he said. “People should enjoy the party while it lasts, but just make sure you know where your coat is.”
Several strategists cite the risk that faster economic growth could cause inflation to increase at a pace that would lead the US Federal Reserve to raise interest rates faster than expected.
Wall Street’s rosy forecasts seem “well supported by the tremendous string of good news, which the economy has delivered,” according to Jim Paulsen, the chief investment strategist of Leuthold Group in Minneapolis.
But the news is too good, he said, adding: “The problem with getting good news is that at some point you can’t be positively surprised any more.”
Paulsen does not expect a recession. But when the economic surprise index, which compares economic data to consensus expectations, is at high levels, equity performance tends to be weaker, he said.
The Citi Economic Surprise index was at 77 last Thursday, not far from its almost sixyear high of 84.5 reached on December 22.
“We’re going to have a 10% to 15% correction at some time in 2018,” Paulsen said. “I wouldn’t be surprised if we’re down for the year. If we get a correction and people get scared, I’ll probably be buying again.”
Investors will keep a close watch on the on US mid-term elections in 2018 because a Republican loss of control of the Senate or the House of Representatives could stall the party’s agenda. In 10 of the last 17 US midterm election years, equity-price moves for the full year followed January’s direction, according to Jeff Hirsch, the editor of the Stock Trader’s Almanac.
Investor moods in January may depend on whether the US Congress reaches an agreement to raise the country’s debt ceiling. Investors will also be hoping Congress can reach a 2018 budget pact by January 19. These are just some of the worries traders are contending with.
But the market has history against it. The S&P 500 rises on average 1.3% in the so-called Santa Clause rally, the period between December 22 and January 3, according to Hirsch. After five days of that period this time, the S&P had risen just 0.1%.
“The failure of stocks to rally during this time tends to precede bear markets or times when stocks could be purchased at lower prices later in the year,” Hirsch wrote in a blog post. (Reuters)