Another year has come and gone. 2017 was a year in which if you saw the economic landscape for what it was – rising employment, increasing earnings, improving consumer confidence, tightening Federal Reserve, and reduced government regulation – then you fared well. Furthermore, if you stuck with large cap and growth stocks, you did even better However, if you held on to disbelief of the strength of the equity markets or clung to political biases, you fared poorly. Furthermore, the resilience of the American economy in the wake of two deadly hurricanes and the shootings in Las Vegas were a testament to the spirit of American citizens and businesses.
Unlike 2016 when the markets kicked off the year with a dramatic 11% correction (on an intraday basis) to the Standard & Poor’s 500 (SPX), in 2017, the SPX rose consistently throughout the year, racking up a 19.42% gain. In fact, the SPX rose every month, except for March, when the decline was less than 1 index point. Market declines during the year were shallow and short lived.
It is quite apparent that the stock market is in a secular bull market. Some believe the bull market began in 2009 but it really began in 2013, once the SPX broke free of the pre-financial crisis highs. I am expecting that the bull market will continue for at least another six to eleven years. However, along the way we will have a correction or two and perhaps a slight recession, which is a naturally occurring part of the business cycle and bull market. I do not see such a recession occurring before 2021 and even that will not end the secular bull market.
Without further ado, in the spirit of the old Wall Street Week with Louis Rukeyser, wherein his panelists were asked at the outset of the year to make their predictions, which could not be changed thereafter, I present My Gut Feeling for 2018:
- The SPX ended 2017 at 2,673.61, which using Bloomberg’s Standard & Poor’s 500 (SPX) earnings estimates of about 119.16 implies an index price/earnings multiple (PE) of 22.44. Standard & Poor’s own analysts estimate that SPX earnings for last year should come in at 124.94 implying a year-end index PE of 21.40. Last year I was expecting EPS of 130 with a lower PE ratio of 20. Thus, I was over on the EPS but conservative on the PE for the SPX. Looking forward to 2018, bottoms-up earnings as complied by Standard & Poor’s, for its SPX index, are expected to increase by about 13.01% to 141.19. Bloomberg’s estimates call for SPX EPS of 147.99. The backdrop for financial markets in 2018 will be implementation of the new US tax legislation and a coordinated global economic expansion. My expectations are that SPX will earn 145 in 2018. Applying an earnings multiple of 21, I am setting a year-end target for the S&P 500 at 3,045, about a 13.9% year-over-year increase. Get your SPX 3K hats ready. With all that said; expect a correction of 5 – 10% during the year which will be unexpected, quick, and temporary.
- The Federal Reserve Open Market Committee (FOMC) raised its short term Fed Funds rate three times in 2017 and five times since interest rates bottomed out at zero in 2015. Fed Funds now stands at 1.25%. The FOMC will be headed up by a new Chair in 2018, Jerome Powell. I expect three rounds of 25 basis points tightening in 2018, with Fed Funds ending the year at 2.00%. Other major central banks around the world will also begin to raise their target interest rates as their respective economies exhibit improvement.
- Despite the FOMC hiking short term interest rates three times in 2017, insatiable appetite for US Treasury securities keeps on propping up that market, Hence, the bond bull market dating back to the early 1980s is still hanging on by a thread. Furthermore, the yield curve continues to flatten rather than widen. We should expect a widening of the yield curve during an economic expansion. All told, the US Treasury market befuddles me. Still, I am going to cling to my belief that the curve begins to shift higher, but the slope of the curve will remain much the same, at least in 2018. If you must invest in fixed income, keep maturities to five years or less. By the end of 2018, I expect the US Treasury market will yield as follows: 5-year 2.50%; 10-year 2.75%; and, 30-year 3.00%.
- We are still in a growth oriented market. Also, we remain in an investment mode which favors large cap stocks. Thus, on a macro basis you want to continue to favor exposure to SPX, Dow Jones Industrials (DJIA), and NASDAQ 100 (NDX).
- On a micro basis, it is prudent to shift allocations away from large cap technology where we are overweight, into more thematic sectors such as infrastructure, energy, restaurants, and financial services. We are not abandoning large cap tech, just harvesting some outsized gains to reallocate into some other sectors which have been laggards for the past several quarters. On a selective basis, there will be some excellent opportunities in individual small and medium cap stocks, but I would continue to shy away from those sectors on a macro basis.
- At some point this year, the US economy will reach escape velocity. Economic growth will be consistently above 3% on the road to at least 4%. This will be due to continuing job growth, benefits from the new tax law, strong consumer confidence and resurgence in the economies of Europe and Asia. I expect GDP in the US to grow by: 3.2% in 1q; 3.5% in 2q; 3.7% in 3q; and 4.0% in 4q.
- Energy prices will creep higher and break out of a long-term trading range. Crude oil prices will trade between $60 and $75 for most of the year because of escalating global demand. The sweet spot of the energy markets will be in the midstream. This sector comprises refining and chemical production which plays into the themes of higher economic growth and infrastructure rebuilding. For example, we have already begun to take positions in Marathon Petroleum (MPC).
- In US politics, there will be the mid-term elections. As is usual, the party in the White House should lose some Congressional seats. With that in mind, let’s not forget that the Democrats are defending twenty-seven of the thirty-five seats up for reelection (that includes independents and a special election in Minnesota), so their task is a difficult one. Should on the other hand, the Republicans maintain control of both houses of Congress or gain some seats, the markets will get an adrenaline rush. I place a 60% chance of the first case occurring and 40% of the second case materializing. Either way, let me remind everyone that the strongest quarter in the sixteen-quarter election cycle is that of the fourth quarter in the midterm election year, so be prepared to get aggressive on September 30. The last time that the SPX declined in the fourth quarter of a mid-term election year was 1994.
- Overseas, there will be two surprises that the markets have not yet factored in. First is that North Korea’s Kim Jung Un, for all his bluster, will come to face the reality of: American military superiority, economic pressure from China and President Trump’s firm stance; to come to the bargaining table with South Korea. The second surprise will come from Iran where a new secular revolution will overthrow the existing religious government, a reversal of the 1979 Iranian Revolution. In general, increasing exposure to international markets via exchange traded funds will be another strategic opportunity worth considering. All told, I have already begun to lighten up positions in defense stocks as they will fall out of favor if one or both of those international events take place.
- There will be major changes in the US Supreme court where two seats will open, most likely that of Anthony Kennedy and Ruth Bader Ginsburg.
Disclosure: At the time of this commentary Scott Rothbort, his family and/or clients of LakeView AssetManagement, LLC was MPC, DIA, DDM, UDOW, QQQ, QLD, TQQQ, SH, SPY, SSO & SPXL — although positions can change at any time.
Scott Rothbort is the President & Founder of LakeView Asset Management, LLC, a registered investment advisor specializing in high net worth private wealth management. For more information on investing with LakeView Asset Management, LLC call us at 888-9LAKEVIEW or request more information by clicking on the contact button on the top right hand corner of the website. LakeView Management, LLC is a Nevada LLC, with its principal office located in Henderson, NV and branch office located in Millburn, NJ
Scott Rothbort is also the publisher of the LakeView Restaurant & Food Chain Report, a newsletter focusing in on food, restaurant, beverage and agricultural stocks. An individual subscription to the newsletter can be ordered at www.restaurantstox.com Furthermore; Scott is also a professor at the Seton Hall Stillman School of Business in South Orange, NJ.
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