Given elevated valuations in the U.S., international markets appear to be relatively attractive, with higher dividend yields and earnings growth potential when compared to domestic markets. Rightsizing allocations is important as risks remain with upcoming negotiations to trade agreements and fluid geopolitical events (e.g. Venezuela, Catalonian Elections, Iran unrest, North Korea, etc.) may dampen those growth prospects.
The Federal Reserve is expected to raise rates three times in 2018, taking the fed funds rate range to 2% – 2.25% by year end. The Fed’s balance sheet will shrink at a pace that will accelerate quarterly in 2018. The new Fed Chair, Jerome Powell signaled his intention to follow the path set by his predecessors. Financial conditions for U.S. equities should be favorable through the first half of 2018, supported by lower corporate tax rates. The equity rally to start 2018 may limit upside in the short-term, however, the strong start is warranted as it reflects the expectation that corporations will use excess cash from tax cuts to spur M&A activity and corporate buybacks.
Fixed income remains a mixed bag of sorts as global investors search for yield and signs of persistent inflation. Due to a lack of durable inflationary pressures, long-term rates are likely to remain well-anchored, causing additional rate hikes to flatten the yield curve. Upside in the current low yielding environment remains limited in 2018, however, slow and steady global growth along with stubbornly low inflation should likewise limit the downside in our view. The value of the U.S. dollar relative to foreign currencies is worth watching in 2018.
The European Central Bank (ECB) remains accommodative and signaled its intention to begin tapering its bond purchase program next year, but have not signaled a likelihood to raise interest rates in the near term. European stocks should continue to perform well in 2018 as the growth story takes shape, despite being plagued by numerous political events (Germany inched closer to forming a new government, Italian voters head to the polls this spring, Brexit continues).
Consensus on when the Bank of Japan (BOJ) will seek to shift away from its accommodative monetary policy remains less certain. Should the BOJ declare the end of deflation, it is likely to announce changes to its overall yield curve control policy, raise the target to the 10-year yield above 0% and reduce its exchange traded fund purchases. Will 2018 be the year Japan experiences inflation?
China and Emerging Markets
Following the 19th National People’s Congress in October, Chinese authorities are expected to ramp up efforts to reform China’s state-owned enterprises and reduce corporate debt, potentially slowing the Chinese economy and hinder overall emerging market equity returns in 2018. Ongoing initiatives to transition the economy from export-driven growth to a consumption-based model could be a source of upside for Chinese equities, particularly the financial sector. Emerging market equities are poised to benefit from stronger growth than their developed counterparts. IMF global growth forecasts still predict China and India will
account for more than half of world growth in 2018. Given emerging market equity valuations remain attractive compared to valuations of developed market equities, we remain committed to emerging markets as a core allocation in a well-diversified portfolio.
For further information, please contact any of our professionals at New England Investment and Retirement Group, Inc.