The stock market has had a good spurt this year, with the Standard & Poor’s 500 up more than 15%. But as the old saying goes, the market climbs a wall of worry, and the long bull run that began in March 2009 makes some nervous about how long it can last. Nicholas Atkeson and Andrew Houghton, the founders of Delta Investment Management in San Francisco, give us the case for why the good times should continue to roll on Wall Street next year:
The stock market, which has done very well in 2017, also should have a good showing next year. Our 2018 S&P 500 Index outlook is up. If the price/earnings ratio remains constant as it has for the past two years, the S&P 500 should be up, in line with earnings of about 11%.
Another record trading day on the New York Stock Exchange. Photo by Spencer Platt/Getty Images
The following 10 factors support our 2018 bullish investment thesis:
Global Economic Expansion – No U.S. Recession In Sight.The global stock market (as represented by the MSCI AC World Index) has posted a gain for 12 consecutive months (a record) and is on track for every single month in a year for the first time in the 30-year history of the index. Every one of the world’s 45 largest economies tracked by the Organization for Economic Cooperation and Development is expanding. Economists are forecasting acceleration in world gross domestic product in 2018 from 2017 levels.
In the U.S., the Leading Economic Index and Treasury yield curve are showing no signs of an impending recession. For the yield curve, if short-term yields are higher than long, that often signals a problem. That’s not the case now.
China Stable and Growing. In late 2015 and early 2016, concerns about decelerating growth in China caused investors to fear a global recession. China did not economically fall apart. Chinese GDP rose 6.8% in the third quarter year-over-year, September retail sales were up 10.2%, industrial production advanced by 6.6% and fixed-asset investment climbed 7.5% in the first nine months of 2017. The feared slowdown morphed into a stable growth environment.
Global Easy Money – Public and Private Credit Markets Pro-Growth. Europe and Japan continue with quantitative easing. In the U.S., corporate debt issuance is at new highs. Money raised in the corporate debt market is bullish for equities as these funds are used for stock buybacks, dividends, capital expenditures, mergers and acquisitions and retirement of more expensive debt. Corporate balance sheets are in excellent shape.
Low Inflation. Inflation in the U.S. has been averaging below 2% for the past 20 years. We believe the record will extend to at least 21 years. Globalization and technology are secular drivers of low inflation and default levels are below 1%.
Earnings at All-Time Highs and Rising. The earnings per share for the MSCI AC World Index (ACWI) is above $30. In the U.S., the S&P 500 consensus earnings estimate is expected to advance by about 11% year-over-year on revenue growth of about 5%, off record levels reached in 2017.
Market Shift to Technology – Strong Secular Growth Drivers. Of the top 10 largest corporations in the world in 2009, only one was a technology company – Microsoft. Today, seven of the 10 largest companies worldwide are technology companies including Apple, Google/Alphabet, Microsoft, Facebook, Amazon, Alibaba and Tencent. The shift to a technology dominated economy provides a boost to earnings growth rates.
Over a fifth of the S&P 500 is represented by the technology sector. Consensus revenue growth for the technology sector in 2018 is 9.4% which should drive 35% earnings growth. In the past month, the revenue growth forecast was revised up from 8.7% to the current 9.4%.
Weaker U.S. Dollar. Another boost to U.S. earnings growth is a weaker dollar. The dollar measured against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc is down about 9% on average year-to-date. This makes U.S. products more price competitive abroad.
Equity Fund Flows Are Positive But Well Below Historic Highs. Globally, investors are putting money into stocks at a decent clip, up over 40% this year. This shows an optimistic sentiment, but hardly a frothy one. The previous high was in 2013, when the market was rebounding from the financial crisis.
Correlations Are Low. The stock market suffers when there are macro fears driving buying and selling. Correlations move toward 1 during times of crisis. Alternatively, correlation falls during bullish times as investors buy or sell stocks on their individual merits rather than a macro sentiment.
Correlations nearly reached 0.9 in 2008 during the financial crisis. During the 1990s bull market, correlations were below 0.4. Today, they are about 0.3.
So there’s good reason for a positive outlook as we go into a new year.
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