What To Expect From Equities In 2018

Summary:  US stocks will likely rise in 2018. By how much is anybody's guess: the standard deviation of annual returns is too wide to get even close to a correct estimate on a consistent basis. Earnings growth implies 6% price appreciation, but tax cuts could boost that to 13%.  Investor psychology could push returns much higher (or lower).

While it's true that investors are already bullish and valuations are already high, neither of these implies a likelihood of negative returns in 2018. That the stock market rose strongly this year also has no adverse impact on next year's probable return.

A bear market is always possible, but is also unlikely. That said, the S&P typically experiences a drawdown every year of about 10%; even a 14% fall would be within the normal, annual range.  It will feel like the end of the bull market when it happens.

The Fed will likely continue to raise rates next year, which normally leads to higher stock prices. While political risks seem high, the stock market usually ignores these. The "Year 2" presidential cycle provides no investment edge.

This article highlights 11 key ideas to explain what to expect in 2018.

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Heading into the end of the year, investment pundits are beginning to share their expectations for how stocks will fare next year. All ten strategists polled by Barron's expect the S&P to rise in 2018, by a mean/median of 6-7% (full article is here; the next three charts from Barron's). Enlarge any image by clicking on it.

Weekly Market Summary

Summary:  SPX, NYSE and DJIA made new all-time highs this week. This augurs well for the months ahead.

The leader, NDX, has fallen into a trading zone; a return to this week's low likely triggers a small correction to price levels from late October.  SPX would follow.

The big event this week is the FOMC meeting on Wednesday, during which a decision to raise the Fed Fund Rate is expected. This would be just the 4th rate increase this economic cycle. Each of the previous events was followed by a pullback in SPX and also a multi-week period where the index did not hold any gains.

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SPX, NYSE and DJIA made new all time highs (ATHs) this week.  All made an inter-day ATH on Monday and closed at an ATH on Friday. For Dow Theorists, both the industrial sector and the transport sector also made new ATHs this week. The dominant trend remains higher.

SPX remains above all its moving averages, all of which are rising. This is the definition of an uptrend. It would take a break of 2620 (blue line) to trigger a head and shoulders pattern whose measured move targets the trading zone created over 6 weeks in October-November (yellow shading). Enlarge any chart by clicking on it.

December Macro Update: Housing and Manufacturing Growth At Multi-Year Highs

Summary: The macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

The bond market agrees with the macro data. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (arrows). The lag between inversion and the start of the next recession has been long: at least a year and in several instances as long as 2-3 years. On this basis, the current expansion will last well into 2018 at a minimum. Enlarge any image by clicking on it.

Weekly Market Summary

Summary:  All of the US equity indices made new all-time highs this week, for the first time since mid-October.  SPX and DJIA have risen 8 months in a row. By some measures, investor sentiment is more bullish now than at any other time in more than a year, driven, apparently, by enthusiasm for tax reform legislation. The current uptrend is extended, and may be getting ready to take a short break, but further gains are likely during the first several months of 2018.

This is the set up as markets enter December, typically the strongest month of the year for equities. As bullish as December tends to be, an intra-month drawdown of 2% has been common, even in recent years.

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For the first time in a month, all US indices - SPX, NYSE, DJIA, COMPQ, NDX and RUT - made new all time highs (ATHs) this week.  The dominant trend remains higher. Enlarge any image by clicking on it.