Where Might the Markets Go in 2018?

When I look at the markets today and think about where they may go in 2018, I believe there are reasons for optimism. Deregulation and tax cuts would seem to set the stage for another friendly investment environment in 2018. But it’s never that easy. Washington machinations often defy logic and a number of factors could conspire to make for a rather extraordinary set of circumstances.

Looking for a roadmap in the year ahead? If history’s a guide, the still-positive vibes from this extended bull run could be an important driver of returns. Getting a sector call right may take on added importance, though, especially as the lines between sectors blur. But there are always common threads that can pull portfolio construction together. In 2018 (and beyond), we believe the disruption of traditional equity sectors is positioned to be a common denominator across the markets.

Will the Bull Market Continue?

Equity investors had it good in 2017. The bull market continued to run amid expectations of easier regulations and corporate tax cuts. Factor in accommodative central bank policies globally, including still low interest rates and in many regions aggressive quantitative easing (QE), and the markets had an environment to thrive in.

As much as central banks tried to coax their economies, their monetary policy adjustments have coincided with improvements in global economic conditions and liquidity. The US dollar depreciated and emerging market currencies strengthened, credit spreads tightened, oil prices recovered, and inflation remained surprisingly low.

What could halt this optimistic view? Many market observers have indicated that massive budget deficits could ultimately negatively change the inflation picture.

What Will the Impact of the New Tax Plan Be?

Senate Republicans pushed through the biggest corporate tax cut in American history in the wee hours of December 1st. The bill’s supporters say it will ignite economic stimulus and inspire businesses to spend and hire more. They also say cutting the top corporate tax rate from 35% to 20% will generate enough economic growth to offset the additional $1.5 trillion the bill would add to the deficit over the next 10 years.

However, the nonpartisan Congressional Budget Office takes issue with that math, and estimates that the bill would fall $1 trillion short of paying for itself, even the economic stimulus is taken into account. Also consider the economy is already at full employment and trickle-down economics may fatten the wallets of owners and not necessarily workers, and this legislation has many skeptics.

What the final bill looks like after the House and Senate reconcile their versions remains to be seen. But at this point tax “reform“ seems to be more of a political win than sound economic policy. The long-term consequences of which are unclear.

Who is the Newly Nominated Fed Chairman? And, How Does Jerome Powell Think?

The market will also be getting to know a new Federal Reserve (Fed) chairman in 2018. Once confirmed, the consensus is that Jerome Powell will pick up where Janet Yellen left off. But some believe growing hawkishness within the Federal Open Market Committee (FOMC) could change the tone of the Fed’s ongoing monetary policy normalization next year.

Inflation pressures seem to be building. If true, that could prompt Powell’s Fed to increase rates faster than expected. Imagine this scenario: a hawkish Fed, global QE ending, and a surprise credit crunch. Removing liquidity from the market and increasing our debt load through the new tax plan could slow or even halt growth.

And it may not be that far-fetched. In what was likely her final testimony before Congress, Yellen was blunt: “I am very worried about the sustainability of the US debt trajectory, our current debt-to-GDP ratio of about 75% is not frightening, but it’s also not low. It’s the type of thing that should keep people awake at night.” Just as a reference point, the national debt is over $20 trillion and growing as we write this piece.

What Market Forces Should We Keep a Close Eye on if the Bull Run Starts to Break Apart?

Economic growth is improving. Fed action will probably be gradual. And tax “reform” should boost corporate profits, at least in the short-run. But after eight-plus years, the current bull market is aging and history tells us that growth often picks up heading into a market peak.

Also, the Fed may be at the mercy of inflation. An upside surprise in inflation would likely quicken the pace of the Fed’s tightening, possibly ushering in a bear market. It could also depress corporate margins if companies are unable pass higher costs on to customers.

Wage inflation looms large. Salaries could rise, pushing the Consumer Price Index (CPI) higher, and convincing the Fed that its 2% inflation goal is within reach. However, according to BofA Merrill Lynch Chief Investment Strategist Michael Hartnett, should wage inflation fail to materialize, “the era of excess liquidity” would continue, bond yields would fall, and the Nasdaq tech barometer would go “exponential.” In Hartnett’s view, that would signal a bubble that might not end until 2019, when a bear market would be triggered by “hostile Fed hiking, Occupy Silicon Valley, and a War on Inequality politics.”¹

Where Can Investors Look for Potential Market Growth in 2018?

The markets are never predictable, but we believe some trends are quite likely to emerge regardless of the Fed, tax reform, or other macro-drivers. For example, the rapid development of disruptive technologies, evolving demographics, and changing consumer preferences could have us in the dawn of a market-disruptive period.

As these themes gain momentum, a new set of companies are likely to drive performance within sectors. Targeting the “Sector Disruptors” using thematic ETFs that are strategically positioned in an effort to ride these transformational waves may give investors a leg up on the status quo.

Sector Disruptors can come in various forms. Technology runs the gamut with the likes of:

• BOTZ: The Global X Robotics & Artificial Intelligence ETF offers exposure to industrial robotics and automation, non-industrial robots, and autonomous vehicles.
• LIT:The Global X Lithium & Battery Tech ETF invests in the full lithium cycle, from mining and refining the metal, through battery production.
• SNSR: The Global X Internet of Things ETF gives access to companies working with semiconductors and sensors, integrated products and solutions, and applications serving smart grids and the industrial Internet.
• SOCL: The Global X Social Media ETF connects investors to companies that look to connect people around the world.

Or, with ETFs focused on the increasingly savvy consumer:

• BFIT: The Global X Health & Wellness Thematic ETF seeks to harness the effects of changing consumer lifestyles by investing in companies geared toward promoting physical activity and well-being.
• MILN: The Global X Millennials Thematic ETF seeks to invest in companies that have a high likelihood of benefiting from the rising spending power and unique preferences of Millennials.

There are also ETFs that seek to invest in companies helping to transform established entities, such as:

• FINX: The Global X FinTech ETF can be a gateway to companies helping to transform established industries like insurance, investing, and third-party lending through mobile and digital solutions.

What’s the Bottom Line for 2018?

Higher potential inflation, corporate debt, and tighter monetary policy stand to be possible culprits in bringing the prolonged rally in risk assets to an end. While the bull market still has its legs, investors taking stock of their portfolios in prep for what’s could come in 2018 may want to:

• Consider their own footing amid what appears to be a shifting sector landscape.
• Understand the shift in traditional sectors, and not just because of the upcoming GICS reclassification.²
• Consider going beyond the ordinary with Sector Disruptors.

We wish you and yours the very best of holidays, and a happy and healthy 2018.