What can Investors Expect in 2018?

As tumultuous as the social and political landscape was in 2017, the financial landscape was anything but. The S&P 500 gained just over 19 percent on a price-only basis (19.4 percent), nearly four times its average annual gain over the past twenty years, and it did so with record low volatility. The MSCI All Country World index rose 22 percent, approximately five times its average return of the past twenty years, also with dramatically diminished volatility. The yield on the ten-year Treasury note began the year at 2.44 percent, and ended it at 2.41 percent. It did trade in a 60-basis point range, but failed to establish any clear direction, mostly because trailing twelve-month core consumer prices fell from 2.1 to 1.7 percent. Shorter maturities were a different story. The two-year note yield rose from 1.19 to 1.88 percent, as the Fed raised the overnight rate three times in the belief that inflation, whose absence was a “mystery,” would eventually show up.

Other enumerated risks to the year’s generally upbeat forecasts also failed to materialize, including a stronger dollar, political strains in the Eurozone, a debt crisis in China and trade disputes. The global economy evolved into a synchronous expansion, and domestic investors were rewarded with a year-end corporate tax cut. In retrospect, 2017 was a year in which almost everything that could’ve gone right for markets did go right, and almost nothing that could’ve gone wrong went wrong.

Could 2018 be as Rewarding as 2017 was? 

As 2018 gets underway, it may be tempting to assume that it will not be as rewarding as last year, not this late in the economic cycle, and certainly not starting out the year with valuations as full as they are. But such an outcome, while perhaps not likely, is not unprecedented. In 1997, after six straight years of gains on a total return basis, the S&P rose another 31 percent and ended the year at the same trailing P/E ratio as today at 22.5X. It then went on to rise another 27 percent in 1998 and 20 percent in 1999 in the longest bull market in history. Of course, it was the era of “irrational exuberance,” and after the P/E ratio reached nearly 30x in 1999, the index proceeded to give back almost 40 percent of its value over the ensuing three years.

If the current bull market survives until Labor Day, it will become the longest in history. For it to get there, once again a lot will have to go right. But from the vantage point of New Year’s Day, it certainly has a chance. With a boost from tax reform, the U.S. economy has a chance to produce growth near 2.75 percent. If it does, it would be the strongest annual growth of this expansion. And, it will be getting help from the rest of the world as global growth accelerates to 3.7 percent, according to the International Monetary Fund’s projection. That would be its strongest pace since 2011, and assumes just 2.3 percent growth in the U.S.

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