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®

The Role of Financial Planners: Lessons from Nashville

Yesterday, I was down in Nashville speaking at the Financial Planning Association’s national meeting. It was an interesting time! Speaking with the young man at the coffee shop, our conversation went something like this: “I’m from Alabama.” “How did you get here?” “Like everybody else, music.” Clearly, this is a one-industry town, from the convention center (the Music City Center) to the signs for the Grand Ole Opry.

Admittedly, I don’t know much about country music. But from what I understand, quite a bit focuses on hard times—working folks getting stuck with the kind of misfortune that happens every day but who keep going despite the pain. That old joke comes to mind: if you play a country record backwards, you get rehired, your girl comes back, the truck starts up, and the dog comes back to life. If you think about it, all of these things, and worse, happen to everyone—and we all need to get through them. Sometimes, it helps to know others face the same pain and have persevered. That’s what I understand about country.

The soundtrack of our lives

Given that, it makes sense that the financial planners are here. Our job, essentially, is to help people plan for—and get through—some of life’s toughest challenges. Most of us do it without guitars (although I know some terrific Commonwealth musicians), but the soundtrack of people’s lives is just the same.

It’s easy to get lost in the glitz and flash of Nashville. And here in the financial industry, we certainly have our high-profile people. But the core of both is the same: helping people get through the story of their lives and helping them keep going and do better. Just as with country music, there’s money and glitz. But the bones are about real people and real problems.

In many ways, we are in a boom. The market is at all-time highs, plus job growth and confidence are strong. Things are good. While we certainly have concerns, for many people the actual problems are those of success. It is easy to get excited about the market highs, the money we are making, and so forth.

Enjoy the good times, prepare for the bad

But the most important things to remember are that the good times will not always be there, that tough times are always not too far off (in one way or another), and that our job—indeed, the reason for our profession—is simply to plan to ride those out. To use the good times to prepare for the bad times.

That doesn’t sound all that exciting and, in the glitz of Nashville, maybe not that much fun. It is, however, what we do.

This lesson was, frankly, not what I expected to take away from this trip. It is, however, a powerful takeaway for me and, I hope, for you. Indeed, I learned quite a bit during the Q&A session after my talk, much of which will no doubt show up in future posts. I always get a lot out of speaking with advisors, and this time was no exception.

 

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.

Authored by Brad McMillan, CFA®, CAIA, MAI, chief investment officer at Commonwealth Financial Network.

© 2017 Commonwealth Financial Network®