Top 10 Investment Themes For 2018

I’d like to start by wishing everyone a happy and healthy new year. As we turn the page from 2017 to 2018, below are ten investment themes that I expect to be influencers of market performance, and therefore in the mindsets of investors and financial advisors alike, in the new year.

Fundamentals and Earnings: While much of this secular bull market cycle, which dates back to March 2009, has taken place on the backs of quantitative easing and other economic stimulus measures from central banks around the world, I believe that future stock growth potential will now largely be predicated on fundamentals, including, but not limited to, earnings growth.

Continued economic growth in the 3% range within the U.S., along with a more accommodative U.S. corporate tax code, should help with the expansion of earnings for well-positioned and well-run companies with sound balance sheets. In addition, higher earnings, assisted by lower tax rates, should make valuations appear more attractive given that earnings are the denominator of one of the more common measures of valuation in the market (i.e. the price/earnings ratio (P/E)).

Value Comeback: Growth outperformed value in 2017 across all market capitalizations and rather significantly in the U.S. large-cap asset class. I believe that this type of market leadership is likely to change along the course of 2018 for reasons beyond just a simple “reversion to the mean.” Value-oriented stocks typically have high relative dividend yields, low price-to-book ratios and/or low price-to-earnings ratios, and tend to trade at a lower price relative to their fundamentals and are thus considered undervalued.

Despite certain more attractive P/E ratios and rising interest rates that are anticipated in 2018, I think value-oriented investment strategies stand to benefit from their relative valuations and income potential, in addition to any increases in market volatility in the new year.

Fed’s 1-2 Punch of Rate Hikes and Balance Sheet Reductions: The Federal Reserve indicated after their December 2017 meeting that they believed that three additional rate hikes would likely be warranted in 2018.  Several Wall Street strategists are forecasting four potential hikes in 2018. I tend to think that three rate increases of 25 bp (i.e. 0.25%) each this year is more likely along with an increased pace of balance sheet reductions, remembering that reductions of U.S. Treasurys from the Fed’s balance sheet can also impact interest rates and serve as an additional means of tightening. If this three rate hike forecast holds true, the Federal Funds Target Rate would end 2018 within the range of 2.00%-2.25%.

With respect to the Fed, while it is expected that new Fed Chair Jerome Powell will likely be similar to Janet Yellen in terms of stance and approach, it will be interesting to see the stances and approaches of the individuals that are appointed to fill the other open Fed positions (including vice chair) in 2018.