It’s hard to know what the future holds, especially after as surprising a year as 2017. But as a start, we’ve collected our experts’ thoughts on the year past and best efforts at predicting the events most likely to impact the financial world in 2018.
The economic story of 2017 was broad-based global growth. Both the International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD) are now projecting annual growth of 3.6% for the year. Growth is largely led by the emerging market economies, spurred by higher global demand, but we are also seeing renewed growth in a number of developed economies.
In the U.S., a weak Q1 was followed by solid growth above 3% in Q2 and Q3; for the year, analysts surveyed by FactSet are projecting a 2.2% expansion. This represents an acceleration from the 1.5% growth we saw in 2016, and is just ahead of the post-recession annual average of 2.1%.
As we close out the year, the fiscal and monetary policy outlooks dominate. Enthusiasm for upcoming corporate tax cuts have sent the stock market soaring, but estimates of the impact on real economic growth are mixed, with most forecasts tempered by concerns about the long-term impacts of running higher deficits. The FOMC instituted three 25 basis point rate hikes this year, and the Federal Reserve is expected to raise rates at least three times in 2018, actions which could run counter to the fiscal stimulus story. In addition to these policy rate changes, interest rates are also likely to be affected by the unwinding of the Fed’s $4.5 trillion balance sheet, but the full extent of that impact is still unclear.
Read more of Sara's observations in (Continental) Europe Outperforms in 2017.
Nikita Pillai, Strategic Consultant, Canada IM Consulting
This year saw the S&P 500 continue its upward trajectory, bolstered by a stronger economy and the prospects of potential tax cuts (among other factors). Five tech behemoths (FAANG) led the market through most of the year with an average gain of almost 50% year to date, and investors are anxious to see whether these stocks—with their steep valuations but strong underlying earnings growth—can sustain their momentum through 2018. Outside of the FAANG, 2017 was a year of tremendous growth for blockchain with initial coin offerings and the market capitalization of cryptocurrencies realizing unprecedented growth.
However, 2017 hasn’t just been the year of the FAANGs and blockchain where tech is concerned; it also saw artificial intelligence moving from the proof-of-concept stage to implementation and being welcomed by more than just the titans of the tech sector itself. With that said, the recent tech sell-off following the GOP tax bill passage prompts us to assess the impact of proposed reforms on different sectors. With the FCC rescinding net neutrality and the Trump administration's plan to preserve the Alternate Minimum Tax, the tech sector’s ability to limit costs may be challenged. Keeping watch on the sector’s resilience to reforms and ever-changing sector dynamics and demands will be interesting.
While global growth is largely expected to continue through 2018, there are a few factors and events that may challenge the resilience of global markets in the coming year. Some of the challenges to positive global real GDP expectations for 2018 may be rapidly rising inflation, aggressive interest rate hikes, steep federal debt levels, and, once again, geopolitical risks in the form of continuing Brexit negotiations and general elections or Presidential elections in Russia, Brazil, and Italy, among others.
Where the U.S. is concerned, measured monetary tightening so as to still allow for a sufficient runway for growth will be important to maintaining market sentiment. Depending on the final tax bill, U.S. tax cuts could materially bolster earnings growth and serve as a driver of market returns in 2018. The impact of corporate tax cuts coupled with the support of fiscal stimulus may power the tailwinds sufficient for markets to deal with tighter global monetary policies and rising inflation, but in the event tax cuts do not go according to plan, markets may react adversely before again stabilizing.
The most common and talked about trend in 2017 was, not surprisingly, data concordance. With the world looking to lower spend and resource costs, the internal focus is to reduce the amount of time spent on data and processes. This has led to a drastic change in the way fintech users deal with vendors. Gone are the days when clients looked for "best of breed" solutions that create a high need for internal data governance and control. Today they're selecting a vendor that can handle the governance of data and technology provisions. This is a big change in the mindset, the drivers of which are generally the C-Level asking for more with less.
In 2018, I'd expect to see consolidation of vendors to offer clients more with less integration and governance and a growth of service offerings to reduce the labor-intensive process and expensive headcount.
In 2017, investors acted in their own self-interest, practically eliminating the middleman. Dollars flowed into dirt-cheap, broad-based, cap-weighted funds like iShares Core S&P 500. Complex strategies and actively managed mutual funds are getting left behind.
Over the past year we saw 10 ETFs capture 34% of the net ETF inflows in the U.S., all of which were broad-based, vanilla funds with an average cost of 0.11% per year. Additionally, 24 ETFs captured 50% of the net ETF inflows in the U.S.; all but two ( Vanguard Value and QQQ) are plain vanilla, with an average cost of 0.1104% per year. Also notable, 52 ETFs captured two-thirds of the net ETF inflows in the U.S., all but seven of which were plain vanilla, with an average cost of 0.1615% per year.
Looking ahead to 2018, it’s hard to beat on cheap vanilla and the efficiency of the ETF wrapper. As investor access to information increases, dollars will flow to the products that serve their interests best. Intermediaries and purveyors of unrewarded complexity will continue to be challenged to attract and retain business.
Patrick W. Starling, Vice President, Sales Engineering
In 2017, investors embraced cloud computing in a huge way, especially the public cloud. As little as 12 months ago, many financial services firms were hesitant about allowing any services or data outside their walls. They’re now quickly embracing cloud services because of the agility, scale, and flexibility cloud systems offer. This is a landmark shift for the industry—both for financial services firms and their technology partners. The same disruption the cloud brought to traditional enterprise IT across many industries is fast approaching financial services.
Another huge suprise came with bitcoin hitting $15,000. The technology holds so much promise from an application perspective, but the industry is still figuring out the fundamentals around cryptocurrencies.
In 2018, I think we're likely to see the first cryptocurrency ETF and for blockchain to enter the trading space. I'd also expect to see data scientists and AI experts become the new industry "bad boys," along with the first AI-driven market event.
In 2017, we saw the estimated (year-over-year) earnings growth rate for the S&P 500 for 2017 hit 9.5%. All 11 sectors are projected to report year-over-year growth in earnings, led by the Energy, Materials, and Information Technology sectors. The estimated (year-over-year) revenue growth rate for CY 2017 is 6.0%. If 6.0% is the final growth rate for the year, it will mark the highest annual revenue growth for the index since 2011 (10.6%).
Ten sectors are expected to report year-over-year growth in revenues, led by the Energy, Materials, and Information Technology sectors. It is interesting to note that the same three sectors that are expected to report the highest earnings and revenue growth for CY 2017 also have the highest international revenue exposures of all 11 sectors in the index.
For 2018, the estimated (year-over-year) earnings growth rate for the S&P 500 is 11.1%. If 11.1% is the final growth rate for the year, it will mark the highest annual earnings growth since 2011 (12.7%). It will also mark the first time index has reported double-digit earnings growth since 2011. All 11 sectors are projected to report year-over-year growth in earnings, led by the Energy, Materials, Financials, and Information Technology sectors.
The estimated (year-over-year) revenue growth rate for the S&P 500 for 2018 is 5.4%. If 5.4% is the final growth rate for the year, it will mark the second highest annual revenue growth for the index since 2011 (10.6%), trailing only the expected revenue growth rate for 2017 (6.0%). All 11 sectors are expected to report year-over-year growth in revenues, led by the Information Technology sector.
Did you know that the U.S. yield curve is almost inverted!? Almost. Inverted. Did you also know that an inverted yield curve has presaged every U.S. recession over the past 60 years? This headline has been inescapable over the majority of 2017, yet it ignores the structural implications of long term investors loading up on duration and driving yields down at the long end of the curve in response to the Federal Reserve’s transparency in getting away from ZIRP and unwinding the balance sheet. It also avoids a strengthening macro environment (albeit scattered strength). Carry is a real thing, even if it is currently minimal. By the way, the yield curve slope is still positive.
For 2018, I have a trio of predictions to ring in the new year! First, the ECB will be forced to abandon QE and (gasp) raise rates as member states argue that the primary objective of maintaining price stability is not being met. Even with year-over-year inflation in the eurozone well under the 2% target, the ECB will bow to the pressure to remove stimulus and risks undermining the nascent recovery. Second, the UK economy continues a painful slide towards recession driven by an ever-growing lack of consumer confidence. Home prices in London drop year over year as the reality of the impact of Brexit settles in like a long winter. Third, Republicans lose both Houses in the midterm elections, confirming “do nothing” status on the administration. . . and pulling 2020 election coverage into 2018!
Read more of Pat’s year-end observations in: A Tale of Two (OK, Three) Fixed Income Markets.
Tom Davis, PhD, CFA, Vice President, Product Manager, Fixed Income Research
The biggest suprises of 2017 were the S&P 500 highs. Markets love stability, and the U.S. administration's lack of ability to pass legislation, which I would have assumed would increase the volatility in the market, resulted in decreased vol (the VIX is trading under 10, at historic lows). Two other factors could also be at play here: tax reform and a general global economic recovery.
As far as predicitons for 2018? I see volatility making a comeback into the market. Potential political issues could also scare the market (e.g., Democrats win the House, impeachment, Pence as commander-in-chief).
I'd also expect to see a bitcoin collapse. Is it a bona fide currency? Is it another asset class? Is bitcoin just the first player, but not the best example of, cryptocurrencies? Today, investors are using it as a store of value, similar to gold (but not perfectly correlated), to hedge against geopolitical issues. If you look at the correlation to other asset classes, it’s surprisingly uncorrelated with everything, which means adding Bitcoin to a portfolio increases the efficient frontier. However, we are still in the infancy of blockchain as a technology, and many other crytopcurrencies exist. Bitcoin has some limitations (for example, 21 million is the highest possible number of bitcoins ever available) that others don’t. Look for Bitcoin to surge around a geopolitical event, but later in the year lose most of its value. Jamie Dimon has famously disparaged bitcoin (but praised blockchain!); however, at the same time the CME has released bitcoin futures.
Captain Obvious (aka Bill McCoy, Vice President, Senior Product Manager, Fixed Income Research)
“The markets will fluctuate.”
The Captain has always enjoyed this quip of JP Morgan’s, in response to a comment on the day’s volatility. While that was the right response to a naïve question, it didn’t really address the different sources of the fluctuation (nor was it intended to (and, no, the Captain isn’t old enough to have been there).
During normal times, the market seeks new equilibria in response to economic and corporate events. From the perspective of an orderly market, sadly, events from the outside world also contribute to the market’s volatility.
For 2017 and on into 2018, the frequency and magnitude of these potential political events dominate the normal market events. Just run through the Captain’s list: war with North Korea, Brexit negotiations, Catalan succession, sweeping tax reform, even the change in power in Zimbabwe. And yet through it all, the Captain manages to sleep like a baby (i.e., waking up crying every two hours).
The crux of the Captain’s anxiety is what happens when the events don’t play out according to the market’s implied scenarios. For rosy-eyed scenarios, the punishment for insufficient suspension of disbelief is usually carnage. For doom-and-gloom scenarios, the reward for avoiding the apocalypse is usually a sigh of relief. This sort of asymmetry of the magnitude of returns is best avoided.
In short, it might be best to fast forward to 2019. Where’s Dr. Emmett Brown when you need him?
For more on a framework for developing stress tests on these types of events, see an article written by one of the Captain’s loyal minions: Forecasting the Unforeseeable: Government Policy Risk Management.
Mergers and Acquisitions
Bryan Adams, Director, FactSet M&A
In 2016 we discussed Brexit, Buyouts, and Berkshire, which made for a very succinct summary, particularly for fans of alliteration. Those three Bs also fit the themes of the year and subsequent transition to 2017 rather well. This year, however, I think James Joyce himself might be happy with the results that 2017 delivered. Every few months felt like a new chapter in Ulysses, with a different narrative, different styles, and new characters dominating the scene regularly.
Global M&A has been contracting and is expected to continue that path for the next six to 12 months, with some expected regional variability. Two major unknown variables include the severity of a potential market correction and the unwinding of central bank balance sheets that will both impact M&A activity.
In the U.S., M&A cycles usually run in 24-36 months (i.e., 30 months growth followed by 30 months contraction). We had 25 months of growth ending in May 2016, and we are only 16 months into contraction.
The 2017 plot is too complicated to make major predictions for 2018, so we're left sifting through the footnotes looking for clues for the next big trend.
I’d like to think a return to normalcy will be the theme, but can anyone remember what that looks like?
Read more of Bryan’s year-end observations in: A Literary Interpretation of 2017's M&A Trends and 2018's Prospects.