"Ask the Investor: What should investors expect from the stock market in 2018?”By: Ryan T. Fulmer
Sunday, January 7, 2018
The last twelve months for the stock market have been terrific with most major indices having increased in value by around 20%. Many clients are asking whether we expect the stock market to continue to rise in 2018 and how tax reform will affect the economy.
Before we discuss corporate earnings and tax reform let’s spend a minute on what makes the stock market go up or down.
Two primary factors are important to analyze: next year’s earnings growth and how much investors are willing to pay for those earnings (or price-to-earnings multiple).
In 2018, we expect organic earnings growth for the S&P 500 to be about 5% (rising from $131 to 138). Most companies will be unable to expand their profit margins due to emerging inflationary pressures, but revenue should continue to grow at a slightly faster pace than the inflation rate.
Investors are always comparing the relative attractiveness of the stock market to alternative investment opportunities, such as: fixed income, commercial real estate and cash. As interest rates increase over the next few years, we expect price-to-earnings multiples to decline towards the long-term average of 15-16x next year’s earnings.
In 2018, we expect the Federal Reserve to increase interest rates about four times, which for the first time in nearly a decade will provide some competition for the stock market. Because of these increases we think the price-to-earnings multiple for the broad stock market will remain around 19x or see a modest decline.
Without assessing the impact of tax reform it looks like the S&P 500 may be worth around $2,622 ($138 x 19 = $2,622) or slightly below the current level.
Don’t get too worried yet.
Corporate tax reform is estimated to accelerate earnings growth to nearly $150 per share, which if the price-to-earnings multiple stayed constant would suggest the stock market would increase another 6% in 2018 (and when dividends are included around 8%).
Should investors be optimistic for 2018?
Yes, but it is important to consider that the current economic expansion is in the later stages of expansion. As inflationary pressures continue to build investors willingness to pay elevated price-to-earnings multiples may decline which could limit upside in the stock market or result in a decline.
Beese Fulmer Private Wealth Management was founded in 1980 and is one of Stark County’s oldest and largest investment management firms. The company serves high-net-worth individuals, families, and non-profits, and has been ranked as one of the largest money managers in Northeast Ohio.
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