What’s the Investment Outlook for 2018?
This past month the Marketplace sat down with Bill Lockhart and Aaron Lockhart of Edward Jones Financial Advisors to discuss recent and future market trends.
Marketplace: By most measures, 2017 was a pretty good year for investors. What can we expect in 2018?
Bill: From early 2016 through 2017 the stock market grew by 50%. That’s a tough act to follow, and it’s difficult to precisely predict the future of the financial markets. The trends point to improved economic growth worldwide, and rising corporate earnings. Both of these are important drivers of stock prices. In the United States, economic growth may be more modest than in other parts of the world, so international stocks could outperform domestic ones in 2018.
Aaron: History shows that lower interest rates benefit the financial markets. We’ve had a long run of low rates, so the Federal Reserve started inching rates up last year. They’re still low by historical standards. Our research people believe that unless workers’ wages and inflation jump sharply, the Federal Reserve will probably remain patient, only raising short-term rates slowly throughout 2018.
Marketplace: Sounds pretty encouraging so far. What do you guys worry about?
Bill: There are always reasons for caution. There are uncontrollable issues like: political uncertainty, changes in economic policies that create more volatility, or ups and downs. In the long-term history of the stock market, a drop of 10% or more – technically called a “correction” – occurs about once a year. Our last correction of 5% was over two years ago. We expect to see more declines of this magnitude in 2018. I worry about people running out of patience...an important part of successful investing...and simply running away. Some researchers call it “investor fatigue”. My job is to keep investors engaged, and on strategy.
Aaron: Even more remarkably, the largest dip in the stock market during 2017 was just 2.8%...the market’s first year without a 3% decline! Our research department feels that in 2018, market volatility could return to normal, including the possibility of a temporary but “material” market correction.
Marketplace: By “material”, you mean...
Aaron: Well, you can’t predict these things, but history shows us that 5-10% temporary market declines are not unusual, and tend to ‘clear the table” for the next economic growth phase. We’ve been in a near decade-long growth market, so a potential ‘pullback’ wouldn’t be a surprise! The government’s recent passage of the Tax Reform bill is an effort to prolong the growth cycle. It’s the first major Tax Reform bill in 30 years but the actual benefits to the economy are not yet clear.
Marketplace: Isn’t that largely going to impact businesses more than individuals?
Bill: The immediate tax benefits to business are obvious in federal tax reduction. There are new incentives for US companies to bring their foreign earnings “home” with less tax. The hope is that money will go to work in research, investment and greater hiring. Since consumer spending accounts for 70% of our national economic output, or GDP, the hope is greater take-home pay, credits and deductions could help drive further expansion. For our clients close to retirement, this could mean an opportunity to save more in their IRA and retirement plans.
Marketplace: Our country has had a turbulent political scene over the past year. If that continues, could it derail our growth prospects?
Bill: We have seen over and over that economics is bigger than politics. We have a robust economy and solid system of checks and balances within our government that’s been tested over time. Many companies compete globally, so they have to hedge the risks of politics, currencies, and regulatory agencies.
Marketplace: OK, so low interest rates are one of the factors helping drive economic growth. Will they continue to go up, and how could that affect future growth?
Aaron: Our head of Research, Kate Warne, feels that in 2018 the Federal Reserve will continue raising short-term interest rates at a slow and cautious pace. However...if averages wages were to rise dramatically this year, and if inflation follows upwards, that might change. Inflation is low, around 2%, and foreign interest rates are low as well. Economists are worried the recent tax cuts and spending will increase debt levels significantly, increasing inflation. Our hope for 2018, is that the Fed continues to raise, or tighten interest rates slowly and deliberately.
Marketplace: So how will this impact mortgage rates? Affordability is a big issue in our valley.
Bill: Absolutely! Any potential Napa home buyer has to be watching the market intently, hoping mortgage interest rates stay low, so they can afford their dream home. Generally speaking as prime rates go, mortgage rates roughly follow. There are other factors in play, including government agency policy, market demand, credit policies...
Aaron: ...and adding fuel to the affordability issue, since the mid-2000’s new home construction numbers have fallen short of our actual population increases in California. Here in northern California, the strain of wildfires and floods has reduced housing inventory. That raised prices in certain markets. Still, mortgage rates have remained historically low. So there is hope for the home buyer!
Marketplace: Given this moderately optimistic outlook, what investment moves should people consider this year?
Aaron: First, investors should rebalance their portfolio. The market’s gains may have increased the value of your stocks so much that they now represent a greater percentage of your portfolio than you had intended – and you may not be comfortable with this increased presence. So, you may want to rebalance your portfolio to a suitable mix of stocks and bonds, based on your goals, risk tolerance and time horizon.
To help reduce the impact of the market’s ups and downs, you may need to add investment-grade bonds and cash investments. (Of course, bonds carry some risks, too, including interest rate risk and credit risk.) Keep some cash available, to make it easier for you to purchase stocks during a market downturn, when prices may be lower.
Bill: Investors might consider adding some international equity investments to their portfolio. As we mentioned, global stocks may do better than U.S. stocks in 2018. Regardless of actual performance, the presence of global stocks can help diversify your portfolio – and diversification can help decrease your overall risk level...although it can’t guarantee profits or protect against all losses. Also, bear in mind that international investing carries some inherent risks, such as currency fluctuations, and foreign political and economic events.
Marketplace: Generally speaking, is “bigger better” for stocks?
Aaron: Remember David and Goliath? Well, if you don’t own many stocks of smaller companies, consider adding them to your portfolio. Smaller U.S. stocks have traditionally outperformed larger ones and may benefit from stronger economic growth and lower corporate tax rates. Be aware, though that small company stocks tend to be more volatile than those of larger companies, so checkout the risks and make sure you’re OK with that investment.
Bill: Investors should consider consulting with a financial professional to determine which of these moves, or any others, are right for them. You can’t control external factors affecting the financial markets, so having a “collaborator” to set your goals and decision points can be a good thing. In the long run, these decisions can help determine your success as an investor.
The recent Tax Reform legislation may offer some benefits to investors. There are reduced tax rates, higher deductibility, charitable deductions, and education savings plans. To really understand how these changes will affect you in 2018, talk to a tax specialist you trust.
Marketplace: Thank you gentlemen.