The U.S. economy keeps humming along without a recession in sight, according to two new perspectives for 2018 from Wells Fargo’s Wealth and Investment Management unit.
“We believe the U.S. economic expansion is in the final third of its term but not about to overheat,” said Paul Christopher, head of global market strategy for Wells Fargo Investment Institute, which released one of the reports.
“If we think of the economy as an automobile engine, new recessions come from revving too hot, not from downshifting,” he said. “The current U.S. economic expansion that began in 2009 is already the third longest on record, a fact that begs the question of its longevity.”
The full Wells Fargo Investment Institute report and the Wells Fargo Asset Management Executive Summary of its 2018 Investment Insights report, released Dec. 6, found that the U.S. economy is set to record its ninth consecutive year of growth. Wells Fargo Asset Management will release its full 2018 outlook and accompanying video series Jan. 9, 2018, on wellsfargofunds.com.
The authors of Wells Fargo Investment Institute’s outlook — “Moving Ahead in an Aging Recovery”— foresee another year of slow growth, low inflation, mixed results for the U.S. dollar, and a further maturing of a U.S. bull market that they believe still has room to move.
“Caution has been the watchword during this expansion and, for example, mortgage debt as a share of gross domestic product is barely above the low it hit in 2015, after seven years of debt reduction,” Christopher said.
The outlook from Wells Fargo Asset Management — “2018 Investment Insights Executive Summary: Watch and Wait (PDF)” — examines a new year in which investors should take a conservative approach to fixed-income investments and remain diversified and patient in an environment of decent global growth and low inflation, said Brian Jacobsen, senior investment strategist with Wells Fargo Asset Management’s Multi-Asset Solutions team.
Wells Fargo Asset Management believes that the key thing to watch for in 2018 is evidence that this global environment of synchronized growth and low inflation might begin to fray around the edges. “Markets have gone from climbing a wall of worry,” said Wells Fargo Asset Management Chief Equity Officer Jon Baranko, “to climbing a wall of disbelief that we can continue with this environment of moderate growth and inflation.”
Muted tax-cut impact
While the Institute expects the government to pass tax cuts for individuals and corporations, the economic boost may be muted. The U.S. economy is near full employment and equity prices appear fully valued, Christopher said.
“Cuts in tax rates are likely to be offset with some combination of lost deductions,” he said. “The total stimulus might boost growth by two or three tenths of a percent, and inflation, too.”
Corporate tax cuts could be more meaningful, he added. “We predict that Standard & Poor’s 500 index earnings per share could grow by roughly 5.1 percent more than we had forecast before tax reform became likely.”
Small businesses could be the biggest winners in any tax reform, Christopher said, “because they already tend to have higher tax rates and fewer deductions to lose.”
Jacobsen concurred, pointing out that small-cap stocks, which generally have a stronger domestic orientation than larger-cap stocks, are considered the most vulnerable to any setback in U.S. tax reform.
Buy low, sell high, and diversify
Despite the positive outlook, investors should remain fully engaged with their portfolios, be diversified in their investment mix, and be prepared to respond to a host of risks that could affect 2018, Christopher said. Risks include a significant uptick in inflation — if the Federal Reserve raises interest rates more aggressively than expected, for example, or if Congress fails to implement growth-friendly policies.
“The current equity-market recovery has surpassed the return and duration of the average bull market. However, we believe there is still more room for it to run,” Christopher said. “We see equity markets as fully valued in the U.S. at this point — but that doesn’t mean reduce investment exposure. Rather, those saving for retirement, for example, should stay fully invested but look for opportunities to reduce overexposure — that means take profits in assets where the share in the portfolio exceeds the investor’s long-term target allocation.”
Instead of expecting conditions to change simply because of the duration of the expansion of the world’s economies, Jacobsen said, portfolio managers are watching indicators like private lending to businesses, housing, and wage growth — along with country-specific factors, such as China’s ability to manage its debt.
“One of the dangers with an environment where everyone knows that things look good is that a shock can shake up the system,” he said. “Yet investors tend to be reactive instead of proactive when such shocks occur, and markets can move a lot faster than individuals. In order to be proactive, we think the most prudent approach is to remain diversified and stay patient, even as investors continue to watch and wait.”
Neither outlook anticipates a repeat of the 2008 financial crisis.
“The narrative today is more about whether this sweet spot of stable growth and low inflation can continue,” Jacobsen said, “rather than whether we’re entering a new paradigm where old valuation models are irrelevant.”
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Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities. The prices of small-cap company stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.
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The views expressed and any forward-looking statements are as of December 5, 2017, and are those of Paul Christopher, head of global market strategy for Wells Fargo Investment Institute, Jon Baranko, chief equity officer with Wells Fargo Asset Management, and Brian Jacobsen, multi-asset strategist with Wells Fargo Asset Management. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the authors and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Investment Institute and Wells Fargo Asset Management disclaim any obligation to publicly update or revise any views expressed or forward-looking statements.
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