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2018 Market Outlook: U.S. Stocks and Economy

Key Points
  • Animal spirits are keeping business optimism alive and well: U.S. growth broadly—and capex and productivity specifically—should remain healthy in 2018.

  • Late cycle tendencies should be on investors’ radar screen: A tight labor market augurs for higher wage growth, higher inflation and  tighter monetary policy.

  • Tax reform would be a plus, but skepticism is warranted: Failure to pass tax reform would dent business and investor confidence, but not necessarily actual growth or corporate earnings.

Better late than never

U.S. economic growth picked up in 2017, driven by easy financial conditions and surging business capital spending (capex). We expect another healthy year for capex and higher productivity, although the economy is likely in the late stage of its cycle.

With a tight labor market, we expect wage growth to accelerate, along with inflation. The Federal Reserve is poised to raise rates at least two to three times in 2018, which is above the market’s current expectations. A continued flattening of the yield curve could begin to put the next recession in our sights, although we don’t expect a contraction in growth for at least another year or two.

Tax reform has the potential to boost economic growth and corporate earnings in 2018. Failure would likely dent soft (confidence-based) economic indicators, but not necessarily hard (quantifiable) economic data.

This fight won't last forever

Late to the party 

Stocks tend to correctly anticipate economic recessions, and although we don’t see one on the horizon in 2018, a flatter yield curve and tighter monetary policy could bring bouts of volatility and elevated risk. Volatility-linked assets could trigger selling if volatility spikes.

Absolute valuations are stretched, but earnings growth has been strong—albeit likely peaking. Interest rates and inflation remain low; as such, relative valuations (to bonds) remain reasonable. Large-cap growth leadership should generally persist in 2018—typical in the later stages of a market cycle.

Attitudinal measures of investor sentiment are likely to remain in optimistic territory, but could come under pressure quickly with any market pullbacks. We expect behavioral measures—like fund flows—to finally begin reflecting the length/strength of the current secular bull market, also typical in the latter stages of a market cycle.

Takeaways

  • Discipline is warranted: Tighter monetary policy and rising (but still low) recession risk means diversification and rebalancing will be increasingly important for investors.
  • Valuation risk: Valuation isn’t a good predictor of shorter-term stock market returns, but elevated levels are a risk if earnings growth disappoints in 2018.
  • It’s about time: Investors, after years of shunning U.S. stocks (in favor of bonds and international stocks) are becoming more enthusiastic (a blessing and possibly a curse).

 

2018 Schwab Market Outlook: Executive Summary
2018 Market Outlook: Global Stocks and Economy

Past performance is no guarantee of future results. Forecasts contained herein are for illustrative purposes, may be based upon proprietary research and are developed
through analysis of historical public data.

The information here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities and investment strategies mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation.

Data here is obtained from what are considered reliable sources; however, its accuracy, completeness, or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

All expressions of opinion are subject to change without notice in reaction to shifting market, economic or geopolitical conditions.

Specific names/titles are for illustrative purposes only.

Indices are unmanaged; do not incur management fees, costs, or expenses; and cannot be invested in directly.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

While the market value of a floating rate note is relatively insensitive to changes in interest rates, the income received is highly dependent upon the level of the reference rate over the life of the investment. Total return may be less than anticipated if future interest rate expectations are not met.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security’s tax-exempt status (federal and in-state) is obtained from third-parties and Schwab does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

High-yield bonds and lower rated securities are subject to greater credit risk, default risk, and liquidity risk.

Diversification, automatic investing and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets.

Index and Term Definitions

S&P 500® Index is a capitalization-weighted index of 500 stocks from a broad range of industries. The component stocks are weighted according to the total market value of their outstanding shares.

The MSCI All Country World Index (ACWI) captures large and mid-cap representation across 23 Developed Markets (DM) and 23 Emerging Markets (EM) countries. With 2,484 constituents, the index covers approximately 85% of the global investable equity opportunity set.

The Nikkei-225 Stock Average is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange.

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

The Bloomberg Barclays U.S. Corporate Bond Index covers the U.S. dollar (USD)-denominated investment-grade, fixed-rate, taxable corporate bond market. Securities are included if rated investment-grade (Baa3/BBB-/BBB-) or higher using the middle rating of Moody’s, S&P and Fitch ratings services. This index is part of the

The Bloomberg Barclays U.S. Aggregate Bond Index (Agg). The Bloomberg Barclays U.S. Corporate 1-5 Year Bond Index is part of the Barclays U.S. Corporate Bond Index.

The Bloomberg Barclays U.S. Corporate High-Yield Bond Index covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.

The Bloomberg Barclays U.S. Floating-Rate Notes Index measures the performance of investment-grade floating-rate notes across corporate and government-related sectors.

The Bloomberg Barclays Global Aggregate Bond Index provides a broad-based measure of the global investment-grade fixed-rate debt markets. The three major components of this index are the U.S. Aggregate, the Pan-European Aggregate, and the Asian-Pacific Aggregate Indices. The Global Aggregate Bond Index ex US excludes the U.S. Aggregate component.

The Bloomberg Barclays U.S. Corporate High-Yield Bond Index covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.

The Bloomberg Barclays U.S. Corporate Bond Index covers the USD-denominated investment grade, fixed-rate, taxable, corporate bond market. Securities are included if rated investment-grade (Baa3/BBB-/BBB) or higher using the middle rating of Moody’s, S&P, and Fitch. This index is part of the U.S. Aggregate.

The Bloomberg Barclays EM USD Aggregate Index includes USD-denominated debt from emerging markets in the following regions: Americas, Europe, Middle East, Africa, and Asia. As with other fixed income benchmarks provided by Barclays, the index is rules-based, allowing for an unbiased view of the marketplace and easy replicability.

The BofA Merrill Lynch Fixed Rate Preferred Securities Index tracks the performance of fixed-rate U.S. dollar (USD)-denominated preferred securities issued in the U.S. domestic market.

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