Heads Up!

According to Charles Schwab research and strategy specialists: “Going into 2018, global earnings growth continues to be strong, while interest rates and inflation remain low and relative valuations of stocks to bonds reasonable–typical of the later stages of a market cycle.

We anticipate solid growth in 2018 and don’t see a recession on the horizon. However, with markets priced for ongoing moderate growth and low volatility, the risks we’re monitoring include the potential for higher inflation and more central bank tightening than expected.

  • Global economic growth lifting earnings is likely to be a key driver for both U.S. and international stocks in 2018.
  • Falling correlations across global stock markets bolster the case for diversification.
  • We expect inflation to rise due to a tight labor market and accelerating wage growth.
  • The Federal Reserve is poised to raise rates two to three times in 2018.

2018 could be the year 10-year Treasury bond yields exceed the three-year high of 2.6%.”

Did You Know…?

You are going to receive a raise in your February paycheck. The IRS is expected to post the new income tax withholding tables this month for your employer to use for payrolls in February. The new withholding tables reflect the lower tax rates stemming from the new income tax law.

Update – Washington

The U.S. stock market has jumped since the November 8th election. We identified 4 initiatives on which the U.S. stock market is speculating to be successfully accomplished early in the Trump administration. What will happen next? It is still to be determined!

The 4 initiatives will have a tremendous influence on the “Heat Map” which forms the basis of our forward looking view of the U.S. economy. We consider the success or failure of the 4 initiatives to be “leading” indicators for the Heat Map.

Below are the 4 Trump administration initiatives upon which the stock market is speculating and what progress, if any, has been made:

  1. Tax cuts and tax reforms benefiting most individuals and businesses. THE MOST SIGNIFICANT TAX LEGISLATION IN A GENERATION WAS SIGNED INTO LAW LAST YEAR. CUMULATIVE PROGRESS TOWARD GOAL: 100%

  2. Infrastructure spending of up to $1 Trillion over the upcoming 7 to 10 years. PROGRESS MADE ON TAX REFORM POINTS TOWARD PROGRESS IN THIS AREA, TOO. CUMULATIVE PROGRESS TOWARD GOAL: 35%

  3. Affordable Care Act amendment, reform or reorganization.THE TAX REFORM LAW REMOVED THE REQUIREMENT EACH INDIVIDUAL OBTAIN HEALTHCARE COVERAGE. PROGRESS TOWARD THIS GOAL IS 35%.

  4. Roll back of government regulations and Executive Orders considered to be difficult for businesses. ROLL BACKS HAVE CONTINUED. CUMULATIVE PROGRESS TOWARD GOAL: 55%

As the action happens in Washington on these 4 initiatives, don’t be surprised if the political “tug and pull” contest results in a wilder than normal stock and bond market.

We will continue to report in future issues on the progress on each initiative.

The “Heat Map”

Most of the time, the U.S. stock market looks to 3 factors (call them the “pillars” which support the stock market) to support its upward trend – let’s grade each of the pillars.

CONSUMER SPENDING: This grade is an A- (favorable). Employees will see larger paychecks soon because of new, lower tax rates. Larger paychecks puts more money in consumers’ pockets; hence, more spending to help stimulate the economy.

THE FED AND ITS POLICIES: This factor is rated C- (Below average).

BUSINESS PROFITABILITY: This factor’s grade is A- (very favorable).

OTHER CONCERNS: The “Heat Map” is indicating the U.S. stock market is in OK shape ASSUMING no international crisis. On a scale of 1 to 10 with 10 being the highest level of crisis, we rate these international risks collectively as a 5. These risks deserve our ongoing attention.

The Numbers

Last week, Foreign Stocks and Bonds increased.  U.S. Stocks declined. During the last 12 months, STOCKS outperformed BONDS.

Returns through 12-22-2017

1-week

Y-T-D

1-Year

3-Years

5-Years

10-Years

Bonds- BarCap Aggregate Index

.5

3.5

3.5

2.2

2.1

4.0

US Stocks-Standard & Poor’s 500

-.3

21.8

21.8

11.4

15.8

8.5

Foreign Stocks- MS EAFE Developed Countries

.9

23.0

23.0

7.8

7.9

1.9

Source: Morningstar Workstation. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. Three, five and ten year returns are annualized excluding dividends.

The Markets This Week

The perfect year is over, even if it ended on a note of imperfection.

The Dow Jones Industrial Average fell 34.84 points, or 0.1%, to 24,719.22 last week, not big deal. But the Standard & Poor’s 500 index fell 0.4%, to 2673.61, and the Nasdaq Composite dropped 0.8%, to 6903.39, their largest weekly declines since Sept. 8.

Despite ending on a sour note, it’s hard to argue that the year could have gone much better. The Nasdaq finished up 28% in 2017, while the Dow gained 25%, and the S&P 500 rose 19%. And the S&P 500 even managed to finish in positive territory each month on a total return basis—the first time that has ever happened. “You don’t get an easier year than that,” says Michael Shaoul, CEO of Marketfield Asset Management. As we said: perfect.

Following perfection is rarely easy, though the market has been pretty good at responding to big gains with more of the same. Including reinvested dividends, the S&P 500 has returned 20% or more 26 times since 1943, and followed that up with another positive year 20 times, says Sadoff Investment Management. The average return following a 20% gain has been 12%. But four of the six down years—1962, 1981, 1990, and 2000—had one thing in common: The Federal Reserve was “dramatically tightening credit,” Sadoff says.

While no one would describe the Fed’s current tightening as “dramatic,” it has been raising interest rates and would like to raise them a few times more next year. The market isn’t buying it yet, especially as inflation remains so low. But some assets are close to levels that may force investors to rethink their expectations, says Jim Paulsen, Leuthold Group chief investment strategist. He notes that the U.S. Dollar Index is approaching a three-year low—it closed down 9.7% in 2017 after declining 1.1% last week—while the 10-year Treasury yield closed the year at 2.41%, just 0.2 percentage point away from a three-year high of its own.

Even oil managed to close the year at its highest level in 2½ years. If they all break out, especially if they do so simultaneously, more inflation could be building than the market expects, and that would force investors to reconsider whether they want to pay 18 times forward earnings for the S&P 500, Paulsen says. “This year felt like a sweet spot,” he continues. “The question is whether that sweet spot can persist.”

What should we hope for? Not another 2017, says Jason Pride, director of investment strategy at Glenmede. With valuations as high as they are, another year of big gains could stretch them even more, even to levels that trigger a selloff. “We’d prefer to see 2018 be tamer for the market,” he says.

As if we have a choice in the matter.

Heads Up!

We are optimistic about the long-term prospects of the U.S. economy. The new tax law will add $1.5 Trillion of stimulus. The upcoming Infrastructure bill will probably be passed in 2018 which will add upwards of $1 Trillion in stimulus. The economy should accelerate as a result of the stimulus. An accelerating economy adds to corporate profits and thus to stock prices over the next 5 to 10 years. All this stimulus is not good for bond investors because interest rates will probably rise during the upcoming 5 to 10 years. Higher interest rates means bonds that you already own will go down in value – and long-term maturity bond prices decline the most. We have already taken steps in portfolios to reduce maturities to attempt to protect portfolios against the risks of higher interest rates.

In the short-term, the stock market could experience a wave of selling in early 2018. Some stock investors have delayed taking profits until 2018 to take advantage of the new tax law rules. It is difficult to predict the length or severity of the selling pressure or even if it is noticeable. But, in the event the stock market drops, we would view this as a buying opportunity (keeping in mind our long-term favorable view).

Did You Know…?

Section 529 qualified tuition plans are modified BY THE NEW TAX LAW to allow the plans to distribute no more than $10,000 in tuition expenses incurred during the tax year for designated beneficiaries enrolled at a public, private, or religious elementary or secondary school.

Update – Washington

The U.S. stock market has jumped since the November 8th election. We identified 4 initiatives on which the U.S. stock market is speculating to be successfully accomplished early in the Trump administration. What will happen next? It is still to be determined!

The 4 initiatives will have a tremendous influence on the “Heat Map” which forms the basis of our forward looking view of the U.S. economy. We consider the success or failure of the 4 initiatives to be “leading” indicators for the Heat Map.

Below are the 4 Trump administration initiatives upon which the stock market is speculating and what progress, if any, has been made:

  1. Tax cuts and tax reforms benefiting most individuals and businesses. THE MOST SIGNIFICANT TAX LEGISLATION IN A GENERATION WAS SIGNED INTO LAW LAST WEEK. CUMULATIVE PROGRESS TOWARD GOAL: 100%

  2. Infrastructure spending of up to $1 Trillion over the upcoming 7 to 10 years. PROGRESS MADE ON TAX REFORM POINTS TOWARD PROGRESS IN THIS AREA, TOO. CUMULATIVE PROGRESS TOWARD GOAL: 35%

  3. Affordable Care Act amendment, reform or reorganization. THE TAX REFORM LAW REMOVED THE REQUIREMENT EACH INDIVIDUAL OBTAIN HEALTHCARE COVERAGE. PROGRESS TOWARD THIS GOAL IS 35%.

  4. Roll back of government regulations and Executive Orders considered to be difficult for businesses. ROLL BACKS HAVE CONTINUED. CUMULATIVE PROGRESS TOWARD GOAL: 55%

As the action happens in Washington on these 4 initiatives, don’t be surprised if the political “tug and pull” contest results in a wilder than normal stock and bond market.

We will continue to report in future issues on the progress on each initiative. 

The “Heat Map”

Most of the time, the U.S. stock market looks to 3 factors (call them the “pillars” which support the stock market) to support its upward trend – let’s grade each of the pillars.

CONSUMER SPENDING: This grade is a A- (favorable).

THE FED AND ITS POLICIES: This factor is rated C- (Below average).

BUSINESS PROFITABILITY: This factor’s grade is A- (very favorable).

OTHER CONCERNS: The “Heat Map” is indicating the U.S. stock market is in OK shape ASSUMING no international crisis. On a scale of 1 to 10 with 10 being the highest level of crisis, we rate these international risks collectively as a 5. These risks deserve our ongoing attention.