The Dow Jones Industrial Average cruised higher and higher in 2017, and investors and analysts are already speculating on whether 2018 can mirror this year’s performance.
The Dow is up 19.3 percent as of Nov. 21.
“It has been a great year for stocks since President Trump's election victory, one that ranks up there with like periods over the past 120 years spanning 31 different elections,” said Ryan Detrick and David Tonaszuck at LPL Financial, in a new research note.
Both call for more gains next year, but issue some qualifiers. Included is the need for more action to spur the economy forward by the federal government, and calmer international relations.
By and large, though, LPL Financial views the 2018 stock market in a favorable light, for the following reasons listed by Detrick and Tonaszuck:
Strong market uptrend. The six major U.S. equity indexes -- S&P 500, Dow Jones Industrial Average, Nasdaq Composite, Russell 2000, Dow Jones Transportation Average, and the New York Stock Exchange Composite -- are each trading above their positively sloping 200-day moving averages. This indicates a prevailing bullish long-term trend.
Solid global breadth. Much like the U.S., global price trends are bullish under the same conditions described above. Healthy global breadth increases the potential for stocks to continue to move higher over the intermediate-to-longer term.
Stocks have beaten bonds. Stocks have soundly beaten bonds since Election Day, according to various indices. The performance gap between the two, roughly 20 percent, suggests continued gains for stocks over the coming year.
Cyclical sectors have outperformed. The combination of technology and financials outperformance, as observed over the past year, has historically been followed by an above-average one-year performance.
The last point may be a critical one for investors, who view choosing the right stock market sectors going forward as something of a Holy Grail, investment-wise. Plugging into the right cyclical sectors in 2018 means more than just peering into a crystal ball.
Interest Rates are Key
That’s where some clear-headed analysis comes in handy. The experts start with interest rates as a critical issue in 2018.
“Looking ahead and anticipating further interest rate hikes by the Fed, cyclical investments will benefit all sectors that have revenue streams heavily-reliant on the level of interest rates,” said Stephan Unger, professor of economics at Saint Anselm College. “Particularly, insurance companies will benefit as higher rates translate to higher profit margins, which in turn is reflected in the insurance company’s stock price.”
In contrast, sectors that benefit from low interest rates, such as the auto manufacturing industry, will likely suffer by higher rate levels, Unger noted.
“Car customers will face higher costs of leasing or financing their cars,” he said, which would drag the sector down.
Other Wall Street experts concur with that assessment, noting that rates are almost certainly going up next year.
“One of the biggest stories in 2018 is the expected increase in interest rates,” stated Robert R. Johnson, president and CEO of The American College of Financial Services in Bryn Mawr, Pa.
According to the CME Groups FedWatch tool, there is a near 50 percent probability that the target fed funds rate will be 75 basis points higher than current levels by next November, he said. In addition, the tool indicates that there is an over 75 percent probability that rates will be 50 basis points or higher.
Consequently, investors would be wise to anticipate higher interest rates and position portfolios to take advantage of those higher rates, Johnson explained.
From 1966 through 2013, the S&P 500 performed markedly better when interest rates were falling than when rates were rising, he added. During falling rate periods, the S&P returned 15.2 percent annually.
“But not all stock market sectors performed equally well in a falling rate environment or equally poorly in a rising rate environment,” Johnson said. “The best performing stock market sectors in a rising rate environment were energy, consumer goods, utilities and food.”
Winners and Losers
For his part, Unger is bullish on the technology sector in 2018, especially in one specific area. Cyclical investments will be a “large issue” for the technology sector, he said. A prime example is financial technology, which makes use of blockchain concepts.
“Blockchain enables a much more efficient way of clearing trades (and) it makes many current processes redundant,” Unger said. “Start-ups in the fintech sector are likely to face prosperous times in the near future. What’s more, tech cycles in general can be considered very sustainable. The blockchain trend will last for at least a decade or more.”
There could be some cyclical losers in 2018 due to blockchain’s rise, as well.
“In place of or in addition to any interest rate impact, blockchain technology will cause pain and suffering for classical business structures, such as the energy industry,” Unger said. “Blockchain’s efficiencies will overwhelm classic business processes.”
Others point to the banking and finance sectors as big winners next year.
“I think the bank and financial sectors will do well in 2018, based on the overall economy moving to higher interest rates,” said Tenpao Lee, professor of economics at Niagara University. “Additionally, the bio-tech and healthcare sectors will also do well as baby boomers are getting older.”
Lee is not as bullish on the technology sector, noting that there’s “no major technology breakthrough” in 2018.
“In the same token, real estate investment trusts will not do well in 2018 due to higher interest rates,” he said. “The energy sector will not do well either, due to oversupply and alternative energy development.”
Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms. Brian may be contacted at email@example.com.
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