December 29, 2017
NEW YORK: Wall Street’s rally could have another leg up next year thanks to a sweeping tax cut and economic momentum, but investors are counting the risks that could abruptly end the party.
The S&P 500 is up about 20 percent with less than a week to go of 2017, and many strategists expect the bull run that began in 2009 to extend into next year, albeit with smaller gains.
Optimism is high following sweeping tax cuts passed by Congress last week that are expected to give an added boost to corporate profits next year.
But strategists and investors highlight the following risks for the year ahead:
The pace of interest rate hikes, particularly after stronger economic data, could derail the market, say some. The US economy grew at its fastest pace in more than two years in the third quarter.
Wall Street’s top banks expect the Fed to raise US interest rates three times in 2018, matching the number of rate hikes this year and the central bank’s own outlook.
“That will be a risk for the market,” Paul Nolte — a portfolio manager at Chicago-based Kingsview Asset Management — said.
“You’re going to risk inverting the yield curve at that point and provide a reasonable competition to equities.”
Some strategists fear inflation will accelerate too quickly as economic growth picks up, creating margin pressure and putting pressure on the Fed to bump up rates faster than investors expect.
“Inflation could be a global game-changer for stock and credit markets,” Bank of America Merrill Lynch analysts said in their 2018 outlook this month.
Wage inflation was potentially the most important factor for the stock market, they added.
Investors will pay close attention to next year’s midterm elections. Democrats are hoping to reclaim seats in Congress, now controlled by Republicans.
“If the Republicans lose the House or Senate, or both, then that would probably be a big negative for the market,” John Praveen — the chief investment strategist at Newark, New Jersey-based Prudential International Investments Advisers LLC — said.
“The market would begin to worry that… the Trump agenda will be stopped in its tracks.”
Rising tensions between the US and North Korea rattled markets around the world in 2017, but Wall Street was able to shake off those worries.
Next year, these and other geopolitical concerns are likely to come up again, strategists said.
“Tensions abound, remaining elevated with North Korea and rising in the Middle East,” Keith Lerner — the chief market strategist and managing director, portfolio and market strategist at Atlanta, Georgia-based SunTrust Advisory Services, Inc — wrote in his 2018 outlook note.
Also, “the political pendulum is swinging toward populism and nationalism across the globe”.
Next year is expected to include key elections in Italy, Mexico, and Brazil, among others.
While strategists expect US earnings to get an added jolt of adrenaline next year because of the tax cuts, some worry it might not be enough to justify stretched valuations.
The S&P 500 is trading at about 18.5 times forward earnings, the highest since 2002, Thomson Reuters' data shows.
Investor sentiment could raise some concerns, according to a December 15 note from Citigroup’s Chief US Equity Strategist Tobias Levkovich.
Citi’s panic/euphoria model is signalling a greater than 60 percent probability of a down market by this time next year, “which is akin to waving a yellow flag of caution”, he wrote.
Bitcoin — the world's biggest and best known digital currency — has been on a tear and could be a wildcard for 2018.
“Bitcoin is on a momentum run, and momentum plays go until they don’t anymore,” Bob Doll — the senior portfolio manager and chief equity strategist at Nuveen Asset Management — said.
Investors, he added, would ask: “‘If Bitcoin can go down a multiple tens of percent, why can’t my stocks as well?'”