The NCAA Men’s Tournament Final Four is set. Kansas, Loyola, Michigan, and Villanova are headed to San Antonio, Texas to determine this year’s college basketball national champion. In that spirit, following our “Sweet 16” commentary last week, this week we share our “Final Four Factors” for the stock market in 2018: economic growth, earnings, trade policy, and the midterm elections.
While we expect a hard-fought battle between these factors and with it, more market volatility, we still see the potential for solid gains for stocks this year and maintain our year-end fair value S&P 500 Index target of 2950–3000. We prefer cyclical portfolio positioning, where appropriate, favoring financials, industrials, technology, small caps, and emerging markets.
Factor 1: U.S. Economic Growth
We see U.S. gross domestic product (GDP) growth accelerating from 2.3% in 2017 to 2.75–3.0% in 2018, including a 0.25–0.50% boost from the new tax law. Though consumer spending has ticked down a bit to start 2017, we expect tax cuts, job and wage gains, and wealth effects to support solid consumer spending growth in 2018. Business spending should get a boost from 100% capital spending prescribed by the new tax law and from repatriation of overseas cash.
Latest developments. Weather depressed first quarter economic data while consumers digested strong spending at the end of 2017. These developments have been corroborated by the reduction in first quarter GDP growth forecasts over the past month: The Atlanta Federal Reserve’s (Fed) GDPNow forecast has fallen from 3.2% to 1.8%, while the New York Fed’s Nowcast forecast has fallen from 3.1% to 2.8%. The slower-twitch first quarter consensus GDP growth figure from Bloomberg, currently 2.5%, has fallen about 0.2% in recent weeks and may soon fall further. Beyond the first quarter, as the impacts of the new tax law flow through economic data and weather-related factors reverse, we expect economic growth to accelerate. Our favorite leading indicators continue to send positive signals.
Bottom line. We still expect 2.75–3.0% GDP growth in the United States in 2018, which should help drive strong corporate profit growth and potentially double-digit stock market gains this year.
Factor 2: Earnings
Corporate America produced the best earnings growth in several years during the fourth quarter of 2017 at 15%, while we have seen the biggest positive revision to S&P 500 earnings to start a year since earnings estimate data have been collected. With economic growth improving, manufacturing activity humming, and analysts’ estimates having soared this year, we expect strong mid-teens earnings gains for the S&P 500 in 2018.
Latest developments. Since the end of fourth quarter earnings season in early March, the biggest development is what has not developed—estimates have not been revised lower in response to the recently announced tariffs. Estimates can be slow to react to macro developments, and trade actions take time to affect goods moving across borders, but we interpret this to mean that earnings fundamentals remain solid. It is also noteworthy that the latest wage data suggested that perhaps corporate profit margins may not face as much of a headwind as was feared after a jump in average hourly earnings data for January; wage pressures eased in the February payrolls data released earlier this month.
Bottom line. We expect mid-teens earnings gains for the S&P 500 in 2018. Protectionist trade policies have the potential to be a drag on corporate profitability later this year. However, we anticipate that the potential earnings impact from trade actions out of Washington will be manageable.