Overall consensus regarding the global economy for the next year is . . . the global economic expansion cycle will continue. This is good for both foreign and domestic stocks. It’s also good for interest rates, as it means that central banks will continue to increase interest rates, as we’ve officially made it out of the recovery phase. In October, the International Monetary Fund increased the global economic growth expectations for 2018. Additionally, global regions beat expectations for 2017 and are expected to do it again in 2018. The one caveat I’ll give to the Bloomberg link discussing central banks and global regions beating expectations is that the article says the global economy is “back to normal.” It wasn’t abnormal. Expansion and contraction cycles are both normal. It is very normal for the economy to be good and bad at different times. I suppose what they might mean is that loose monetary policy is coming to an end, and we have a bit of breathing room in front of us for a while.
Imagine the economy as a wheel, a 360 circle. When the economy is doing poorly we’re rotating somewhere through the bottom part of the cycle/circle. When the economy is doing well, we’re climbing or cresting across the top part of the cycle/circle. Climbing up the bottom part of the cycle from the trough is slow and difficult, like when you’re climbing up a big hill. This climb continues to be tough as your ascending the top of the cycle until you reach the crest. Then, downside tends to be swifter and deeper as gravity takes hold.
Expansions are excellent for business overall. Consumers have more money in their pockets that they’re using to buy durable goods and discretionary items. They also trade up for more expensive staples. They spend money. Money goes to companies. Companies use that cash flow to service debt, invest in deeper or broader target markets, engage in research and development, acquire other companies or new technologies, and to pay or increase dividends to shareholders. When executed correctly, these activities result in increased value, that is, stock share prices go up.
Rising interest rates sometimes induce people to save more, as they can get income from bond investments or savings. However, even as interest rates ARE rising, they’re still at very low levels when compared to historical rates. So, they’d have to go a lot higher before investors would choose to exchange stock (equity) investments for bond (debt) investments, or even for FDIC insured options such as CDs. In other words, the rates won’t be high enough next year to attract investors away from the stock market. Rates also won’t be high enough to induce saving instead of spending. However, for the huge portion of the population entering or in retirement, they’ll welcome any additional income they can get from low-volatility bond-type holdings. And, this may give them some nominal amount of additional pocket money, which they might choose to spend, and might have some incremental effect on expansion as well.
As you may have read in the tax update that I sent out this week, many tax payers will pay a lower rate. Remember, I attempt to stay apolitical and present only the parts that I need to present that are relevant to the current discussion. So, this will only discuss positive possible outcomes based on lower personal and corporate tax rates. While the tax reforms will put limited extra cash in each individual’s wallet, the overall increase in spending nationwide could provide a boost for American businesses as well. Unfortunately, there’s no real evidence for the “trickle down.” But, our domestic economy is primed for something similar to happen, and the tax cuts do give businesses extra margin that they can use to pay higher wages. The fuel is low unemployment. In a recent podcast episode of The Indicator, called “Where’s my raise?” slow wage growth was discussed. We’re just now reaching the point in employment levels where employers must begin to compete for workers, whereas over the last nine years we’ve been in the opposite situation. That is, it’s becoming a “buyer’s market,” so to speak, in the area of employment. Employers will have to begin increasing wages at a higher rate to attract and retain employees. It’s a slow process, but the tax reform that was passed could prime the bulb.
Another indicator that we’re in the expansion phase of the economic cycle is that “cyclical sectors” are performing better. You’ll recall from one of my October newsletters that I mentioned my personal indicators were showing strong hold/buy positions in cyclical sectors, while “defensive sectors,” which perform better in the bottom part of economic cycles were showing weak hold/sell positions. The Reuters article from October that referenced the IMF’s 2018 outlook, also mentions the upturn in indicators for the cyclical sectors. Cyclical sectors include basic materials (think building and growth), consumer discretionary (think retail and luxury brands), financial services (think about people borrowing for large auto or home purchases or investing), and real estate (think building and growth, home buyers, business expansions). Defensive sectors include consumer staples (think about the things people buy no matter how bad the economy gets, like toothpaste, toilet paper, and soap), healthcare (a bad economy doesn’t stop people from getting sick or injured), and utilities (even when the economy is bad, people tend to try to keep the lights on). Other sectors not mentioned have less correlation with good and bad cycles.
I consulted with 19 different sources, news articles from various outlets and analysts’ white papers from various asset management companies, in order to determine the industry consensus about 2018. That consensus is in line with where I stand on global economic growth. I remain in favor of the view that we’re in a 1990s type bull market—one that goes up for a long time. This would indicate that we still have several years of gains left. However, we are overdue for a correction simply because a lot of stocks may be priced too high. Additionally, other indicators of a correction still stand, such as correlation with the movements of some other asset classes, that could mean a correction is coming. If you’ve read anything I’ve written before or if we’ve had a discussion, you know that I believe:
- the market always goes up eventually,
- corrections are normal,
- we’re better off participating in upside than sitting on the sidelines waiting for the market to decline,
- rules-based and evidence-based investing means I’m ready for any outcome.
In short, we’re positioned for continued growth, but could see a shorter term pull back. That’s normal.
Some headwinds that we could face would include uncertainty about our government, a geopolitical event involving someone like North Korea, or problems with US fiscal policy such as with the budget deficit. The continued investigation into Russian meddling may be nothing or may be something, but only time will tell. People seem to talk until they’re blue in the face on both sides. The key to remember is that until something does happen all of that talk is just speculative. We really know nothing. If the outcome of the investigation created uncertainty, the market would react negatively. Markets don’t like uncertainty. If we became involved in a conflict with North Korea, that’s a geopolitical event that would cause market turbulence. The budget deficit and national debt continue to be a problem. It’s hard to say whether or not our lawmakers will do anything about either one anytime soon. The problem is that the amounts have grown so large that we’d have to take severe measures, even austere ones, to resolve the issues. It would make lawmakers even less popular than they already are. So, these guys and gals who might already be unpopular or worried about voter approval have a conflict of interest. They seek to preserve their seats, not fix deficits and debts. I highly doubt that fiscal policy or a lack thereof will have any impact on markets in 2018. I think that’s a can that gets kicked down the road a few more years until it is miraculously resolved or reaches a flashpoint where resolution becomes unavoidable. I don’t anticipate that any of these potential headwinds will be major barriers to longer term growth, or to growth in 2018.
Happy New Year!
