Outlook 2018: Fund companies weigh in

Next year looks good but not great for stocks and bonds, barring a spontaneous collapse in prices

By John Waggoner

Dec 21, 2017 @ 1:39 pm EST

Barring an asteroid collision, 2017 will go down in history as a very good year for stock investors. The S&P 500 index has soared 22.04% this year, including reinvested dividends, and the MSCI EAFE international index has jumped 24.18%. Even bonds have eked out some gains, despite an increasingly hawkish Federal Reserve Board. The Bloomberg Barclay's Aggregate Bond Composite total return gained 3.05%.

The question: What does 2018 look like? Very good years in the stock market are usually followed by okay years in the stock market, said Sam Stovall, CFRA's chief investment strategist. That's what many major mutual fund houses are suggesting in their 2018 outlooks. Here's a rundown on what fund companies are saying about next year.

STOCKS

T. Rowe Price: Accelerating competitive change should continue to benefit a relatively small group of mega-cap companies that have created dominant technology platforms ... Barring unpredictable political or economic shocks, we expect steady earnings growth in 2018; however, year-over-year comparisons will become more challenging.

Vanguard: For 2018 and beyond, our investment outlook is modest, at best. Elevated valuations, low volatility, and secularly low interest rates are unlikely to be allies for robust financial market returns over the next five years. Downside risks are more elevated in the equity market than the bond market.

BlackRock: We prefer to take economic risk in equities over credit given tight spreads, low yields and a maturing cycle. We see rising profitability powering equity returns, especially in Japan and emerging markets (EMs), but earnings growth could wane. We like financials and tech.

Fidelity Investments: We expect the global expansion to remain intact in 2018, but also foresee some fraying in the near-perfect backdrop that drove asset prices up and volatility down in 2017. Our cyclical asset allocation view is to prioritize diversification in order to guard against the increasing uncertainty of outcomes and potential pickup in volatility that we expect during the course of 2018. Within the context of smaller cyclical tilts, we remain favorably disposed toward international equities and inflation-resistant assets.

Capital Group: Market levels suggest that better investment opportunities may continue in non-U.S. markets. Consider that the U.S. accounts for 52% of global market capitalization, near a historic high, and its market cap is 106% of its GDP. Granted, a number of factors justify a relatively higher share of market cap for U.S. companies, as it is the home market for many of the world's dominant companies, and roughly 40% of Standard & Poor's 500 Composite Index company earnings come from overseas.

Also consider that the forward P/E ratio for the U.S. market, at 17.9, is notably higher than other major markets. Conversely, the emerging markets share of global market cap appears relatively modest compared with its contribution to GDP. And, emerging economies are expected to contribute half of global GDP by 2021.

State Street Global Advisors: We do not believe today's high valuations portend the death of the bull market. After all, U.S. economic data trends are positive. Economic growth is steady, evidenced by declining volatility between quarter-over-quarter GDP growth and unemployment remaining low. High valuations do indicate lower expected returns based on historical analysis, however.

Franklin Templeton: We believe the recovery in emerging markets, which has been underway since 2016, is showing little sign of abating. We think right now Asia is the most exciting region in emerging markets. It offers a range of opportunities, from China, South Korea, India and Taiwan to countries such as Indonesia.

BONDS

Franklin Templeton: While persistently high core inflation could spur rates to climb faster than anticipated, we think the more likely scenario is a modest uptick in inflation, particularly over the coming year. We believe inflation has been persistently low as a consequence of several factors, primarily globalization and technology. We do not see these impacts easing materially over the near term, so while core inflation may tick up, we think it unlikely to increase in dramatic fashion within this timeframe.

BlackRock: Wages are grinding higher and one-off factors, notably an adjustment to how wireless data costs are measured, will wash out of inflation readings. As a re?sult, we see higher U.S. yields ahead and prefer inflation-protected bonds over the nominal variety.

PIMCO: Barring a zombie apocalypse or a sudden spontaneous collapse in asset prices, the current Goldilocks environment of synchronized, above-trend global economic growth and low but gently rising inflation will likely persist in 2018. With the unemployment rate likely to drop below 4%, we expect some upward pressure on wage growth and consumer price inflation, with core CPI inflation rising above 2% in the course of the year. Core PCE inflation, the Fed's preferred measure, should rise as well, to 1.7% from 1.4% currently, making some limited progress toward the 2% objective.

By positioning defensively, we believe we will be better prepared to take advantage of opportunities presented in more difficult market conditions rather than having to play defense — and to outperform in more difficult markets. We see U.S. TIPS (Treasury Inflation-Protected Securities) as offering attractive valuation, diversification versus corporate credit and a valuable hedge in case higher inflation risks amid late-cycle fiscal expansion in the U.S. are realized.

State Street Global Advisors: Long-term inflation expectations remain below 2% and are low by historical standards. Short-term real rates rebounded from below zero, but are still low relative to prior cycles. More people are entering retirement … typically requiring more traditional sources of income generation, like U.S. Treasuries. Persistent buyers of bonds likely will cap long-term rates.

Vanguard: We urge investors to be cautious in reaching for yield in segments such as high-yield corporates, not only because of the higher expected volatility that accompanies the higher yield, but also because of the segment's correlation to the equity markets. While not attractive in terms of return, TIPS could be a valuable inflation hedge for some institutions and investors sensitive to inflation risk.

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