Q1 2018 Quarterly Outlook

In our Q2 2017 Outlook published in April we shared our enthusiasm that after years of sluggish growth and an anemic consumer and business cycle, the US economy was finally showing signs of growth commensurate with a true business recovery. Since that writing, our confidence has been buoyed by a 3.2% GDP growth rate in the third quarter, a pickup in consumer confidence, a surge in industrial activity, and green shoots of inflation.

Although skepticism regarding the benefits of tax reform remains high, we encourage investors to reserve judgment. Corporations will deploy the excess cash flow into both growth opportunities and employee wallets –see Walmart, the largest US employer, announcing a broad increase in its minimum wage. We saw the economic signposts prior to tax reform, therefore we expect the additional tax stimulus to be nothing but beneficial to the business and consumer outlook –despite some of the naysayers.

While the economic growth statistics remain encouraging, our concern is that its duration could be short-lived due to the accompanying inflation potential and Federal Reserve response. A tight labor market already encouraging wage growth, rising commodity prices, high manufacturing utilization, and a three-handle on GDP are all ingredients for future inflation, potentially eliciting a Fed response that may catch complacent investors off guard. Even a small rise in long-term rates, whether aided by inflation fears or the Fed’s unwinding of QE, resulted in a negative investor response earlier this year.

Outside of the US, both Europe and Japan are either contemplating or initiating actions to limit and unwind central bank balance sheets. 2018 is expected to be the first year in seven in which the big three central banks issue more bonds than they are repurchasing via QE -essentially the beginning of what we expect will be a very long and gradual unwinding of easing policies, likely creating pressure on bond prices.
Modest inflation is healthy for the economy and for equity markets, a reason we believe equity market returns will be attractive in 2018. Where we think 2018 will differ dramatically from 2017 is that the volatility of returns will accelerate –with inflation and interest rate volatility being the culprits. While volatility will be uncomfortable, we believe that corporate fundamentals will continue to support markets in the year ahead.

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