Market Commentary

Weekly commentary providing analysis with an outlook for the equity market.

November 15, 2017

Scott Wren, Senior Global Equity Strategist

Agility in 2018

  • While we expect some tax legislation to be passed by Congress, stock market volatility will likely increase in 2018 as the Federal Reserve continues to hike interest rates and the economy only grows at a modest pace.
  • We think it is likely investors will be presented with potential opportunities to make portfolio adjustments in the coming year. In 2018, we will need to be on our toes and ready to act.

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For most of the last eight years investors could have pretty much put their domestic equity exposure on cruise control. In virtually every calendar year during this recovery, our work suggested the market would assign a higher valuation (in terms of the 12-month trailing price-to-earnings, or P/E, ratio) to the S&P 500 at the end of the year than it did at the beginning. It took quite a while, but toward the end of last year, at least based on our work, the large-capitalization S&P 500 finally moved to what we considered “fair value” for that point in time. Then came the surprise election result last November, and the stock market started to move above our fair-value estimate based on a number of factors, including anticipation of less regulatory headwinds for stocks, a more business-friendly environment, and prospects for corporate tax reform. In addition, some institutional asset managers began “chasing” the market higher to keep up with their benchmarks.

But we think 2018 is stacking up to be different than the previous handful of years. Based on our analysis, and as we indicated when we released our year-end 2018 targets, we think there is a good chance the S&P 500 won’t see much net movement between now and the end of next year unless we see some type of corporate tax legislation signed into law. Note that our current published equity targets for year-end 2018 do not include any tax-reform assumptions. We look for the trailing P/E ratio for the S&P 500 to be lower at the end of next year than the current 20.4x level. The bottom line for us is, when it is all over and done with, we think 2018 will be a rather flat or slightly down year in the stock market unless Congress passes a tax-reform bill. Saying that, we do think there will likely be opportunities as we expect volatility to increase. Also, we think there is a better than 50 percent chance that some modest changes in the corporate tax structure will occur. We are working through a number of scenarios right now, in fact, to gauge the effects on earnings and, potentially, index targets.

So, as an Equity Strategy team, we will need to be on our toes next year. Since the lows of March 2009, stocks have made a robust move to the upside. But volatility has mostly been lower over that time frame relative to other past recovery periods. During the last 23 months, we have had just two meaningful moves to the downside, and they were both short-lived. In the first six weeks of 2016, stocks took a dive as fears over a collapse in China’s growth rate gripped the global equity markets. Then a few months later, in the wake of Great Britain’s decision to eventually leave the European Union (“Brexit”), stocks took a big, but brief, hit. This year has featured very little back-and-forth volatility as the market’s M.O. has largely been to slowly grind higher, particularly in recent months.

Corporate tax cut hopes have fueled the recent leg-up in stocks, in our opinion. But even if we are correct and some modest tax reforms are implemented, the market is likely to offer investors potential opportunities as volatility increases. Equity agility is going to be critical to performance next year.

Risk Considerations

All investing involves risks including the possible loss of principal. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities.


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