Investment Outlook (1/31/2018) Justin Dammel, CFA

Transcription

1 Investment Outlook (1/31/2018) Justin Dammel, CFA

2 Market & Economic Themes - January 2018 Throughout most of January, stock markets accelerated higher, with corporate tax cuts and increased earnings projections providing key ingredients for the rally. Towards the end of the month, volatility has increased, bringing about the first significant pullback in nearly two years. Positives: Corporate Earnings & Tax Reform - Core S&P 500 earnings, coupled with tax reform, could produce +20% earnings growth in Overseas cash repatriation will add to U.S. growth in a number of ways. Positive Sentiment - Both Consumer and Chief Executive Officer (CEO) sentiment indicators are approaching all-time highs. Yield Curve - Despite narrowing, the current spread does not indicate a recession in Wild Cards: Market Trend - A logarithmic scale of the S&P 500 shows the index at one standard deviation below trend. Interest Rates and Inflation The recent increase in interest rates has investors concerned about inflation, the higher cost of borrowing and competition for high-yielding stocks. Market Valuation - Price-to-Earnings remain high (but are recently improving) and are supported by historically low interest rates. Oil - Demand growth and OPEC/Russia production cuts have balanced supply vs. demand levels for oil. Negatives: Geopolitics / Trade Policies - Geopolitical conflicts and trade disagreements can be unpredictable and cause stock market pullbacks. Volatility Pick-Up Short-Term volatility has spiked, which indicates unsettled markets. 2

3 Corporate Earnings and Tax Reform - Core S&P 500 earnings and the benefits of a lower corporate tax rate could boost 2018 earnings +20%. - With U.S. Corporations now able to bring back cash from overseas at a reduced tax rate, expect a variety of market-positive uses (M&A, Share Buybacks, Dividends, Payroll Expansion, Capital Expenditures). 3

4 Positive Sentiment - Both Consumer and Chief Executive Officer (CEO) sentiment indicators are approaching all-time highs. 4

5 Yield Curve is Still Accommodative - The spread between the 2 and 10 year U.S. Treasury Yields remains near 60 basis points. - In the previous two yield-flattening cycles, stock market performance accelerated after yields narrowed to 60 basis points. 5

6 S&P 500 Trend-line - A logarithmic scale post-2008 shows the S&P 500 has dropped to nearly one standard deviation below its trend-line. 6

7 Interest Rates - The 10 Year U.S. Treasury yield recently broke above 2.65%, a rate not seen in nearly four years. - Investors will be watching future global central bank actions and U.S. inflation trends to anticipate how high the 10 Year U.S. Treasury yield could rise. - A 3.0% 10 Year U.S. Treasury yield could put additional pressure on higher yielding stocks, and even pressure the overall stock markets. 7

8 Market Valuation - When factoring in most of the corporate tax reductions, the forward PE valuation of the market is marginally higher than a year ago (even after a +25% gain). - A low interest rate environment is typically supportive of high valuations. - A market correction (~10%) could make valuations attractive. 8

9 Oil Fundamentals slowly improving Positives for oil prices: - Global oil supply/demand is balanced and annual demand is growing by 1.4 million barrels a day. - Global commercial inventories are down to 2015 levels. - Exploration & Production spending has declined dramatically over the last few years and will have to be increased to keep up with future demand. - Geopolitical events can flair up and boost oil prices. Negatives for oil prices: - OPEC and Russia are withholding 1.8 million barrels of production in 2018, but releasing this production in 2019 could over-supply markets. - Alternative Energy sources are becoming more economical. 9

10 Geopolitics / Trade Policies - Disputes around the world occasionally flair up and have the potential to cause stock market pullbacks. - The map below highlights a few ongoing concerns, but more conflicts are sure to occur. NAFTA Re-Negotiation U.S. Budget Nuclear North Korea Middle East Conflicts 10

11 Volatility is increasing - Investors have become concerned in the near-term, with the Spot VIX rising higher than the 3-month VIX future. - This typically indicates markets will be volatile for a month or two, before moving back towards new highs. 11

12 Important Disclosures: Past performance is not indicative of future results and diversification does not ensure a profit or protect against loss. All investments carry some level of risk, including loss of principal. An investment cannot be made directly in an index. Robert W. Baird & Co. Incorporated 12