Is This as Good as it Gets?

In many ways 2017 was a very good year to be an investor. Markets across the globe moved higher as synchronized global economic growth took hold and corporations expanded revenue at the strongest rate in years. Market volatility was nearly non-existent, especially in the second half of the year, and an increase in confidence helped bolster already elevated market valuations.

By many measures the U.S. economy is in the best shape it has been during any point in this expansion. As I’ve written about before, this Goldilocks scenario of increasing synchronized global growth along with relatively low inflation is the perfect environment for business owners and investors. GDP growth exceeded 3 percent the previous two quarters and we think this can continue. Consumer confidence is at the highest level going back to the early 2000s, business confidence keeps moving higher, and both the manufacturing and service sector PMIs are registering well above expansionary levels. These impressive soft economic data readings (expectations based) are now being increasingly joined by hard economic data, meaning the economic growth is actually materializing. However, as good as things appear, we keep asking ourselves, is this as good as it gets? Could the 2017-2018 economy be peak growth for this expansion?

For nearly two years I have written about the economic impacts of low oil prices and the strong dollar. In 2016 these negatively impacted economic growth, but in 2017 these themes reversed and provided a nice boost to the economy. By many measures we anticipated these transitory benefits to dwindle by 2018, potentially putting further expansion at risk. However, the recent passing of the Tax Cuts and Jobs Act of 2017 may have bought this expansion more time. U.S. corporations will begin receiving a significant benefit from a newly lowered corporate tax rate, which decreased to 21 percent from 35. Some of the benefit will go toward new investments in equipment, facilities, and technology; some will go toward filling open job positions and increasing wages; but, I suspect a large percentage will go toward buying back shares, increasing dividends, and paying off debt. Either way, overnight, many corporations will print higher earnings. Our expectations for full-year 2018 S&P 500 earnings increased substantially after the passing of the bill. However, this shot in the arm to earnings might only buy the expansion another year. Looking forward to 2019, corporations will not have the easy year-over-year tax benefit to fall back on and without a sizable increase in economic activity, underlying organic growth may disappoint.

Which leads us to the all-important question, if 2017-2018 economic growth is the strongest point of the expansion, what happens when markets begin to anticipate slower earnings growth in 2019 and beyond? Certainly, with equity market valuations at elevated levels, there is significant downside risk when growth starts to slow. It is an inevitable part of any economic expansion; however, we may have 6-12 months before it is a concern. In the meantime, I suspect many investors may be jubilated seeing the strong tax-fueled earnings growth of 2018.

If you would like to see more data and charts about the economy and various financial markets please see our Monthly Insights book, which is published at AllegiantPA.com.

Click Here to View the Full Book

Benjamin W. Jones, CFP?, AIF?

Chief Investment Officer

Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance in no guarantee of future results. All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. The Dow Jones Industrial Average is a price weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Russell 3000 is a market capitalization weighted equity index encompassing the 3,000 largest U.S. stocks. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The Emerging Markets Index is a float-adjusted market capitalization index that consists of indices of 21 emerging economies. The CBOE Volatility Index is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. The Shanghai Composite Index is a stock market index of all stocks (A shares and B shares) that are traded at the Shanghai Stock Exchange. The ISM Manufacturing Index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The Non-Manufacturing ISM Report on Business is a purchasing survey of the United States service economy, published by the Institute for Supply Management. Investments involve risk including possible loss of principal amount invested.