Hope you are all having a wonderful Holiday season! One of the holidays is New Year’s Day, meaning that 2018 is nearly upon us. What do I think is on tap for 2018? Please read on, and remember that this advice is worth what you are paying for it. Warning: These are only my opinions. I don’t know what will actually happen in 2018, but I see some actions that I think will be factors.
One could reasonably argue that the upturn in stock prices since the market bottomed in March 2009 has been fueled by Central Bank actions through low interest rates and bond purchasing. The US Federal Reserve has stated that they are ending their bond-buying program that has ballooned its balance sheet to $4.5 Trillion with a T. They are putting the bond-buying program into reverse, but very slowly. The Fed’s balance sheet will remain above $4 Trillion for 2018. The halt in the bond buying, at least, will remove some of the fuel that has propelled the stock market.
While the US Fed has at least halted its bond buying, the European Central Bank has not halted its similar program, and won’t be doing so for at least the next 2 years, although it will slow down. This will mean that international interest rates will remain low (negative, in some places in Europe and Asia). The US Fed has stated they intend to raise rates by maybe 0.75% in 2018. The Fed’s rate-raising initiative will be hindered by low European rates due to ECB bond buying.
The current spread (difference) between 3 month and 10 year US Treasury securities is about 100 basis points, or 1.0% (Source: Bloomberg). If the US Fed actually does raise short-term rates (they can’t do anything about long-term rates) by 75 basis points in 2018, and 10-year rates remain the same as they are now, that will narrow the 3-month to 10-year spread to 25 basis points, which is really small. You can lend money to the government for one rate for 3 months, or you can lend money to the government for 10 years and receive 25 basis points more return. Which would you choose? I believe it is likely that 10-year rates will rise as the Fed increases rates, but not by 75 basis points. That means that the Yield Curve will continue to flatten, as it has flattened during the past year. A really flat yield curve is not a good sign because an inverted yield curve usually portends a recession.
Since the Central Banks worldwide are still providing fuel, stocks will continue to rise. There may be corrections, but the basic trend will be upward. There are many algorithmic traders out there today that are programmed to “buy the dips” that any mini-correction over the past year has bounced back quickly. The rubber band trade has worked, and I believe it will continue to work. The test will be to see what will happen when there is a “flash crash” or another event that causes an immediate, deep correction that undercuts the Buy signals from the algorithmic traders. This sort of happened in August 2015 due to an issue with China, and again in early 2016. Markets have obviously recovered from these China-related issues. Hedgie Kyle Bass has bet big that there will be another, deeper China crisis. It hasn’t happened yet but it might. Barring this type of external issue, look for stocks to increase.
India has been strong and other emerging markets have followed in the past year. As with US stocks, the fuel is there to keep buying. Interest rates will remain low. The threat of geopolitical confrontation remains high. Isis as a government has been beaten back but of course, terrorism remains a threat. However, the stock market has shaken off terror issues in the past. Unless there is a huge 9/11-scale attack, terrorism will not become a huge factor in the stock market. I like the Emerging Markets ETF (NYSE: EEM).
Expect to pay more at the pump. All producers benefit from higher prices. Saudi Arabia’s ARAMCO wants to go public in 2018 and its offering will benefit from higher prices. Look also for higher gas taxes as states and locals try to raise money for roads and for general budget shortfalls. We here in California just got hit with another gas tax hike. Electric cars make only a small dent. Tesla is beset by production issues – not to say you should short Tesla stock, but that I believe Tesla’s unit sales will fall well short of projections because they can’t bang out their cars fast enough.
I believe there will be no action regarding North Korea. I believe that issue will get solved with South Korea and Japan nuking up, which won’t make China happy. Unfortunately, we will have to live with North Korea’s nukes. I believe the bigger threat is in the Mideast. Iran and Saudi Arabia are increasingly at odds (Shia vs. Sunni), and it may not end well. This is the greatest geopolitical risk area, in my opinion. I don’t think they are capable of being diplomatic toward one another. We will see how much the US and Russia get drawn in.
If you are long now in stocks, stay long. If you are long in bonds, don’t get longer, but don’t sell. Although I don’t see a major increase in inflation because the forces that have kept inflation low to date remain in place, I think global growth will continue and this will cause commodity prices to increase, including oil. Keep an eye on Iran and Saudi Arabia.