Wells Fargo Investment Institute is expecting moderate appreciation of the dollar, improving gross domestic product (GDP) growth, and inflation moving above the Federal Reserve's 2% target.
U.S. GDP Growth
U.S. Inflation (CPI)
S&P 500 Index
Federal Funds Rate
10-Year U.S. Treasury Yield
West Texas Intermediate Crude Oil per Barrel
Source: Wells Fargo Investment Institute (WFII), November 30, 2017. Subject to change. Forecasts are based on certain assumptions and views of market and economic conditions, which are subject to change.
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As we head into 2018, the U.S. economic expansion is maturing, but the positive feedback loop from 2017 remains in place. This is the ninth year of the recovery, making it time to compare risk and reward more diligently.
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Positive global economic growth and stronger investor sentiment have helped fuel equity market gains worldwide in 2017. And, as inflation slowly builds and central banks around the world reduce their extraordinary stimulus, fixed-income yields have been rising.
With bond yields and equity returns on the move, many investors are understandably cautious and are asking logical questions. Questions like:
Is the end of the bull market in sight?
This is by far the question we get the most. The economic recovery is maturing.
Now, make no mistake, the later years in an economic expansion can be among the best for returns. But they’re also a time when strong optimism can drive markets ahead of themselves, above and beyond what the underlying fundamentals can support over time.
If rewards are low, why take more risk?
In 2018, we believe investors will be challenged to balance risk and reward. Historically, as economic expansions mature, equity prices tend to rise faster than their fundamentals improve, while exuberance in bond markets can compress yields into ever narrowing credit spreads.
Sentiment can ebb and flow during an expansion, and given our outlook for more modest returns across asset classes in 2018, we now see investors in some markets taking on more risk than we believe is necessary.
It may be tougher today to find investments that either trade below their intrinsic values or that are fundamentally cheap, but we want to encourage vigilance, so that investors are alert to when and where market optimism is detaching prices from their underlying values.
Where are the investment opportunities around the globe?
Well, we believe international equities are earlier in the recovery cycle than U.S. equities, and we see better growth potential in Developed Markets and Emerging Markets than we see in the U.S.
We encourage investors to rebalance their portfolios after 2017’s big U.S. market run-up.
Above all, we recommend that investors stay engaged with their investment plans. Investors usually prioritize returns, but a basic principle of investing is — and should be — to try and limit the losses in their portfolio.
And those losses often come from taking unintended risks. So, our report is really about considering risk and return more closely and maybe in new ways, especially being more global.
For more information on where we see opportunities in 2018 and to learn which investment themes we’re watching in the coming year, download our Wells Fargo Investment Institute 2018 Outlook report titled: Moving Ahead In An Aging Recovery.
Different investments offer different levels of potential return and market risk. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Bonds are subject to interest rate, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates.
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So far, data indicate that the U.S. economic expansion that began in 2009 is likely to continue into 2018. In our view, the economy shows no near-term signs of overheating, in part because the credit picture remains favorable. At this point, a repeat of the global financial crisis of 2008 seems unlikely.
The U.S. dollar may deliver mixed results. Another year of potentially slow growth and low inflation may mean the U.S. dollar performs stronger against the yen but modestly weaker against the euro and emerging markets currencies.
Investors should avoid both exuberance and complacency. The slow-but-steady economic recovery may be encouraging some complacency that the economic expansion could run indefinitely. When markets become complacent, investors should weigh risk and reward even more carefully.
U.S. household debt service
Credit card and auto debt have hit new records, but mortgage debt accounts for 70% of household liabilities and remains below its 2007 peak. Most importantly, low interest rates and rising wealth and wages put the ratio of debt payments to total income below its 2008 peak.
Sources: Federal Reserve Board, Bank for International Settlements, and Wells Fargo Investment Institute, October 5, 2017
Shaded area represents time frame of a U.S. economic recession. Disposable income is
defined as income after taxes.
Performance of the small-cap Russell 2000® Index and mega-cap S&P 100 Index relative to the S&P 500 Index
Small-cap stocks have tended to underperform in the latter half of bull markets. Mega-cap stocks have tended to outperform in the last phase of a bull market. Recent small-cap and mega-cap performance suggests that the bull market still has room to run.
Source: Bloomberg and Wells Fargo Investment Institute, November 13, 2017
Past performance is no guarantee of future results. An index is unmanaged and not available for direct investment. The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index. The S&P 100 Index is a subset of the S&P 500 Index and measures the performance of 100 major blue-chip companies across multiple industry groups. The S&P 500 Index is considered representative of the U.S. stock market.
Slower growth — but still growing
The equity bull market is maturing but has room to run. We anticipate continued revenue and earnings growth for S&P 500 Index companies in 2018, with revenues expected to increase at a 6.4% pace, versus 5.9% in 2017, and earnings per share expected to grow 12.4%, versus 10% in 2017 (or $145 versus $129), fueled by tax reductions and higher operating margins. We do not expect the bull market to end in 2018.
International stocks may offer more growth potential. International equities are earlier in their cycle and could outperform U.S. equities.
Selectivity may become more important. Cyclically dependent (versus defensive) companies should continue to benefit from global growth.
Supportive conditions, but caution is in order
In our opinion, investors should use current yield levels as a proxy for expected 2018 fixed-income returns. However, as we head into 2018, investors need to take into account potential late-cycle risks and be thoughtful regarding fixed-income portfolio positioning.
Favor investment-grade-rated debt. We recommend that investors upgrade their fixed-income credit profiles.
Consider Treasury Inflation-Protected Securities (TIPS). Investors should consider allocating a small portion of their portfolios to TIPS to help mitigate an unexpected increase in inflation expectations.
Intermediate-term fixed income should continue to perform. We believe intermediate-term fixed income should continue to provide investors with modest returns coupled with limited downside volatility.
Difference between 10-year and 2-year U.S. Treasury yields
Short-term rates often move above longer-term rates before a recession. We forecast that short-term rates will remain below long-term rates at the end of 2018, consistent with our belief that the economic expansion is likely to continue.
Sources: Bloomberg and Wells Fargo Investment Institute; November 7, 2017
The shaded area represents a time frame of a U.S. economic recession. Yields represent past performance. Past performance is no guarantee of future results. Current yields may by higher or lower than that quoted above. Yields fluctuate as market conditions change. One basis point is equal to 1/100 of 1%; 1% equals 100 basis points.
Equity REITs trading at a discount to net asset value (NAV)
Real Estate Investment Trusts (REITs) now trade at a 4.8% discount to their underlying real estate holdings, as compared with the 2.5% average premium they’ve traded at since 1990. The typical premium makes sense because REITs offer advantages that include professional management and access to capital, making a discount compelling.
Source: Green Street Advisors and Wells Fargo Investment Institute; monthly data from February 1, 1990, through September 1, 2017. For illustrative purposes only.
All REITs premium to NAV is a weighted average (weighted by NAV shares outstanding) of all U.S.-listed companies in Green Street’s coverage universe, excluding hotels and those without a published opinion. Green Street’s coverage universe includes 128 REITs and other publicly traded real estate companies, including 83 companies in North America and 45 in Europe. NAV is the REIT equivalent of book value and represents the estimated market value of a company’s property assets less any liabilities. Past performance is no guarantee of future results.
Still in a bear market
The pesky commodity bear supercycle continues. However, we expect the average REIT to deliver mid- to high-single-digit gains, in large part because REITs today offer decent fundamentals at a good value. We expect a similar picture will prevail in 2018 but that investors will increasingly focus on value.
Commodities: down or sideways. We expect downside action in oil and gold to begin in 2018 and sideways price action for most commodities.
Consider the pros and cons of Master Limited Partnerships (MLPs). MLPs generally should track oil prices, which we expect to be flat to down. However, we believe MLP performance should be respectable because of generous dividend yields.
Focus on active management
Recent hedge fund performance has tended to support our thesis that a regime change was underway for alternative investments and that hedge fund performance would improve. This also supports our forecast that, as the era of quantitative monetary stimulus began to wane, the environment would become more favorable for active management.
There are strategies worth considering. Dispersion strategies such as long/short equity and credit should perform best, followed by event driven strategies focused on special situations and stressed/distressed credit.
The illiquidity premium is likely to increase. Offered by private capital strategies, especially private credit, the premium is likely to increase in 2018 as lending conditions tighten and credit markets weaken.
Hedge fund returns have improved over the past 12 months
Hedge fund returns for the 12 months ended October 2017 showed a significant improvement compared with the average rolling 12-month returns over the past eight years.
Sources: Bloomberg and Wells Fargo Investment Institute; monthly data from October 1, 2008, through October 31, 2017
Past performance is not guarantee of future results. The performance shown is for illustrative and informational purposes only and does not predict or depict the performance of any investment or the likelihood of achieving any return on an investment. The asset classes shown may not perform in a similar manner in the future. An index is unmanaged and not available for direct investment. Index returns do not reflect any deduction for fees, expenses, or taxes applicable to an actual investment. Unlike most asset-class indices, HFRI index returns reflect fees and expenses. Please see the end of this report for the risks associated with the representative asset classes and definitions of the indices.
The HFRI Indices are based on information self-reported by hedge fund managers that decide, on their own, at any time, whether or not they want to provide, or continue to provide, information to HFR Asset Management, LLC. Results for funds that go out of business are included in the index until the date that they cease operations. Therefore, these indices may not be complete or accurate representations of the hedge fund universe and may be biased in several ways.
2018 Focus Themes
What to watch for in 2018 and beyond.
What risks are investors facing at this stage in the
How can investors prepare for this inevitable outcome?
What do these developments mean for investors?
What do these changes mean for retirement in the future?
Investment Expertise and Advice to Help Clients Succeed Financially
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