2018 economic forecast

2018 Midyear Outlook: Will the Economy and Markets Keep Growing?

After the performance we saw last year, we had high hopes for the economy and markets in 2018, but the first half of the year was disappointing. Expectations softened as the stock market pulled back early in the year, economic growth slowed, and risks—largely in trade—rose. As we hit midyear, though, those initial hopes appear to be more realistic than they were even a month ago.

For example, job growth has accelerated this year, bringing us, more or less, to full employment. And with continued wage income growth and ongoing high confidence, consumers are both able—and willing—to spend. Businesses are confident, too, and business investment is showing signs of accelerating. Meanwhile, tax cuts and fiscal stimulus have taken government from a headwind to a tailwind.

With this foundation, we should see continued growth in the second half, fueled by the following:

  • Employment—which is likely to continue to grow, albeit at a potentially slower pace than in the first half of the year
  • Businesses—which should keep and even increase their investment as capacity utilization rises and labor becomes scarcer
  • Government spending—which should continue to revert to growth now that the tax cuts and spending deal are in place

What does this mean, then, for real economic growth? We can expect to see growth of around 3 percent, with the potential for better results. Assuming consumer spending growth of around 3 percent, business investment growth near 5 percent, and government spending growth around 2 percent, this 3-percent figure appears both reasonable and achievable. Combined with an anticipated inflation level of 2 percent for the year, nominal growth should approach 5 percent.

Opportunities and Risks

As always, there are risks to this outlook—both to the upside and the downside.

Looking at the economy, if wage growth increases, consumer spending power could increase more quickly. If consumer borrowing were to pick up, spending could grow even faster. Business investment could respond to improving demand and rise more than expected. Local and state governments could increase investment and hiring more than expected.

Politics presents the greatest risk on the downside. Here in the U.S., the midterm elections will certainly disrupt the political process. If it appears likely that Democrats will take one or both houses of Congress, it could raise substantial economic uncertainties. In the nearer term, the administration’s trade policies could disrupt supply chains and increase costs, which would have consequences for financial markets. Abroad, risks include North Korea and continued political turmoil in Europe. Any of these could result in systemic damage and create real drag on the U.S. economy and financial markets.

Another major downside risk is rising interest rates. In its most recent press conference, the Federal Reserve (Fed) seemed to declare victory on both employment and inflation, which could mean faster rate increases than previously anticipated. Current expectations are for at least two more increases in 2018, and with long-term rates constrained, we could be at risk for an inverted yield curve, which historically has been a sign of upcoming recession.

Turning to the stock market, the rest of 2018 could be quite exciting, in both a positive and a negative sense. Earnings growth should continue to improve overall on the heels of economic expansion, as companies reap the benefits from the tax cuts. As growth accelerates and risks from Europe and North Korea subside, valuations may rise back to previous highs—or even higher on a positive shift in investor sentiment.

There are certainly risks to the market on the downside, however. Valuations are at or above 2007 levels; in other words, they are at historic highs. Profit margins are also at historic highs, and the tailwinds that got them there are disappearing as interest rates rise and wage growth continues to pick up. That’s not to mention that rising interest rates could make bonds more attractive as an investment, which would also weigh on valuations.

Looking at the past three years, a typical lower-end multiple has been 15x forward earnings. Based on current analyst expectations of $176.52 in S&P 500 earnings for 2019, and using a 15x multiple, the 2018 year-end target for the index would be around 2,650, which represents a decline of about 5 percent from mid-June levels. This is a reasonable downside scenario for the end of the year.

If the economy continues to grow, and businesses continue to operate at very high profitability levels, valuations could rise back to around 17x forward earnings. This reasonable upside scenario would leave the S&P 500 around 3,000 at year-end, an increase of almost 8 percent above current numbers.

 Are Things Looking Up?

This is definitely not a prediction of a flat, boring market. Absent the Fed’s security blanket, the market should be more volatile, and it likely will be. A sell-off at some point in the next six months is very possible, with the rising concerns about trade one potential cause. In addition, as rates rise, investors will likely reassess the attractiveness of U.S. stocks versus fixed income. Meanwhile, accelerating wage growth should have a negative effect on profit margins, even as it boosts the economy as a whole.

While the downside risks are real, the ongoing strength of the U.S. economy should protect us from the worst and even continue to offer some upside. The second half of 2018, therefore, seems likely to provide us with more growth in the real economy and financial markets.

Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict.

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Matthew Lang is a financial advisor located at 236 N Washington St, Monument, CO 80132. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 719-481-0887 or at matt@langinvestmentservices.com.

© 2018 Commonwealth Financial Network®

Distinguishing between signals and noise

Distinguishing Between Signals and Noise

I have written about this concept before, but given some conversations I’ve had recently, I think it’s a great time to revisit it. When trying to understand both what is happening and (ideally) what is going to happen, we need to be able to identify what is important—and what is not. In other words, what signals should we pay attention to—and what noise should we ignore?

Economic and market signals

There are several key indicators that investors need to pay attention to, in my opinion.

For the economy, what really matters are jobs, consumer and business confidence, and whether the Federal Reserve is stimulating. These are the real signals, which is why I track them every month, most recently on Tuesday. While you can learn from some of the other data, much of it is just noise.

For the markets, we need to understand when we’re heading toward a bear market. The important signals here are recession, oil prices, the Fed (again), and valuation levels. In this case, we also have to look at more immediate indicators, such as trend lines and changes in debt levels, but again this is what and why I track them monthly, most recently yesterday.

Putting the noise in perspective

When you focus on the signals—which helps you get the big picture right—you can keep the other data (i.e., the noise) in perspective. In a presentation I’ve been giving for some time, I point out that over the past several years, we have been worried about both a strong dollar and a weak dollar, a rising China and a collapsing China, high oil prices and low oil prices. In each case, if we looked at the longer-term data, there was nothing to worry about—and so it proved. While each of those trends was worth watching, they were not part of the core signal.

Today’s economic concerns are turmoil in Washington, DC, North Korea, and the Middle East. The second two speak for themselves; I am over 50 and can’t remember a time when we have not had problems with both North Korea and the Middle East. As for Washington, DC, the concerns may be real, but from an economic perspective, history suggests that they simply won’t matter that much.

Today’s worry points for the markets are the low level of the CBOE Volatility Index, occasional small dips, and the underperformance of individual companies. Each of these, for various reasons, simply has not been indicative of trouble in the face of the positive signals.

Keep calm and carry on

With strong job growth, high consumer and business confidence, and a Fed that’s still adding vodka to the punch bowl, the economy is likely to keep growing for some time. With improving corporate earnings, high investor confidence, and low interest rates, the market fundamentals remain sound—and so, very likely, will the markets.

That’s not to say this will always be the case. It won’t. Again, though, by identifying what matters—the signals as opposed to the noise—you will be better prepared to make the right decisions when the time comes, and not before.