Last year’s members of the Star Tribune’s Investors Roundtable — like many other prognosticators across the nation — were woefully short in their Standard & Poor’s 500 predictions. The markets surged early on the perception of the new business-friendly administration of President Trump, and continued to grow on strong corporate earnings and growth in nearly all global economies.
Several panelists took the unusual stop of updating their year-end forecasts in the middle of the year.
When our panel met in December 2016, the S&P 500 was at 2,191 and panel members were predicting the S&P 500 index to be flat to up 10.6 percent. Our experts’ picks ranged from a low of 2,190 to a high of 2,424. It finished the trading year Friday at 2,673, up nearly 20 percent, making Craig Johnson, technical market strategist at Piper Jaffray Cos., our winner with his pick of 2,424.
This year, our panel met on Dec. 11 — before the historic tax cut package passed Congress — and debated various topics. They are optimistic the economy will continue to grow and that the second longest bull market will continue, but they have added warning notes. They have doubled down on their prediction of more volatility in the stock market and caution that small changes to interest rates, inflation or other factors may have bigger impact than in the recent past.
There is less consensus this year: one expert predicted the market would retrench, while the median forecast was a 7.5 percent increase in the S&P 500 index.
Here are highlights from the discussion, edited for length and clarity.
Reviewing 2016, why were so many analysts off on their stock market predictions?
Jim Paulsen: I don’t think at the time there were many people talking about a synchronized global expansion. So, to me, what drove the market this last year was chronic positive economic surprises. It created absolutely no inflation or interest rate pressure, and so then you’re in a real sweet spot of better-than-expected growth, no rate pressure, no inflation pressure, valuations go nuts along with earnings, and you get a big move. So, I thought we’d reach 2,600. I did say that last year. I just thought we’d reach it by summer and be back at the start point by now.
Roger Sit: I felt comfortable with the 2 to 2½ percent gross domestic product growth forecast, and it ended up being stronger than that on a global basis, closer to 3 percent. And certainly the anticipation of what’s going on with President Trump, and just the reduction in anti-business sentiment — even though the Trump administration has not been able to pass a lot yet, just relative to the previous administration — not that there are tailwinds, but there are just less headwinds.
Carol Schleif: There may not have been big legislative pushes [before tax legislation], but there was something like close to 900 rules and regulations that were stopped or peeled back. The fact that that happened really flipped the business optimism and the virtuous cycle of consumer optimism.
Beth Lilly: The relief that you’re going to have a more pro-business president in the office changed the mind-set of a lot of CEOs and a lot of corporations. We’ve seen this economy propped up by the consumer for so many years, and now I think what’s really compelling, and I’m optimistic about 2018, is you’re seeing a business-led recovery. You’re starting to see more jobs being created, a possible infrastructure bill, and so we’re going to actually see reinvestment by corporations back into the economy, which we haven’t seen in this recovery at all.
David Joy: We raised our forecast in the middle of the year, which is something we hadn’t done in the recent past. We went into the year predicting the S&P 500 would end at 2,365, something like that, and we raised it at the end of June to 2,570. We felt as though at that point there was a lot more visibility on second half earnings growth, and the market was OK with the Fed raising rates on their intended path. And that was a little bit of a surprise.
Mark Henneman: We’ve talked about in the past of the lack of new companies and the shrinking base of stocks, and I wonder if we’re underappreciating the scarcity value of stocks themselves. You know, there’s all that money that’s looking for a place to go, and we continue to raise the multiple, and I think that can be contributing to what we’re seeing now.
How long can this bull market last and what shape does it take going forward?
Lisa Erickson: If we look at history, the average duration is around four to five years. We’re in year eight. So it is long. If you actually plot out historically what bull markets typically look like, what you’ll see is that this line is longer, but it’s shallower. So even though it’s gone on a long time, it’s not like we’ve had rip-roaring 30 percent gains every year. So I think as we look forward, we are actually continuing to be optimistic.
Todd Hedtke: If there’s anything I’m concerned about, it is this extremely low level of volatility and potentially the volatility bubble. I talk about volume control more broadly, and some of the machines that are out there that are trading today are keeping volume right now real low. But what happens if we have a little bit of a shock, a little bit of a hiccup or a little bit more bad data in China? The unwind is going to be pretty quick, and it could be a little bit ugly.
Schleif: And the other critical thing is, is you’ll have a newly reconstituted Fed, and nobody really knows how they’re going to behave. And do they opt to get behind the curve or ahead of the curve? So the bond market could easily drive a lot of what goes on from a fear standpoint. We don’t even know what incoming Chairman Jerome Powell’s communication style is going to be. Is he going to go back to an Alan Greenspan mode where you have to try to read between the lines or a Paul Volcker mode, which was even more that, or will he continue the Janet Yellen mode?
Joy: You know, if this bull market lasts until Labor Day, it will be the longest in history, and from where we sit right now, I think it has a chance to do that, because the economy looks good. Earnings growth looks good. Maybe tax reform adds to that a little bit. But I would agree, to us the Fed is the biggest risk to that. And not so much that they make a policy mistake, which they could. We think the Fed is going to raise rates three times next year.
Craig Johnson: Overall for me, I’m still bullish. I think we’re still in this secular bull that’s going to last many more years. Just keep in mind back in 1981 to ’99, you made about five times your money. From ’51 to ’66, you made 15 times your money. I still think you’ve got more room for this market to work. But be prepared for a setback, and be prepared to be buying stocks at that point.
Paulsen: To me the economy seems younger than the market in the sense that — where I know the calendar, it’s very old, but if you look around the globe, most of the economies in the world have re-recessed since the start of this recovery, so in a sense they’re much younger in their recoveries by calendar standards. The U.S. is very young by character. I mean, we’ve not had a cap spending cycle, let alone an excess. We’ve not had a housing cycle, let alone an excess. We’ve not had a lending cycle, let alone an excess. We haven’t brought savings down to negative. We’ve done none of this because it has been fear based all along. So it’s almost like you’re just barely coming out of the recession, and you’re finally getting some confidence.
What could hurt this economy?
Sit: I think we’ve got to not only watch what’s going on in the U.S., but we’ve got to watch what’s going on in Europe, the European Central Bank, China, because they have their debt issues there as well. And then the Bank of England. I think it’s been a surprise to them how strong the economy has stayed there, regardless of what’s happening with Brexit.
Lilly: I’m less optimistic going into 2018, and there’s little signs — there’s “Help Wanted” signs everywhere. All these jobs [are] in the core of the economy, they can’t find anybody to work these jobs. So at some point, that has to bleed into a slowdown, or they have to raise rates, they have to raise wages, which means inflation will pick up. So that doesn’t sit well with me.
Sit: I agree on the labor situation, and it’s kind of surprising that we’re at a 4.1 percent unemployment rate, but I think what’s happening is that there’s a huge disconnect between the people out there who are available or people who are employed right now relative to the job skills that are needed. That’s what I think the big problem is right now.
Schleif: The 6.1 million or 6.2 million jobs aren’t all a disconnect of skill sets. A big chunk of that is that employers aren’t paying. They’re trying to hire like it’s 2008. And if you look at the statistics put out by HR consultants and headhunters, the headhunters are saying, “I’m not even going to take certain jobs, because they’re trying to hire the perfect candidate at a 2008 sort of mind-set.” They’re not offering the increases or the salaries.
What things should investors be keeping their eye out for?
Henneman: When a company has a slight slip-up, its stock is down 20 percent as if it’s never going to recover, and there’s a lot of stocks out there like that, that created great opportunities, and on the smaller company side, we’re seeing that especially. So you can talk about a market you’re a little worried about, but it’s not hard to find value and opportunities out there if you’re willing to go out there and look for them.
Erickson: These shifts in how the market is being driven do create opportunity. One thing that everybody has to be careful about is that the timing and the nature of that opportunity may shift because of the fact that there’s momentum now with people all acting the same way. You can have value in the market, but it can take longer for it to be discovered. So that’s really the tough part, and finding those undiscovered gems and allowing them to hang in there is going to be key.
Lilly: I think there’s three potential black swans. One is the ETFs (exchange-traded funds). If we see a correction in the ETFs and everybody gets their statements and they’re like, “Wait a second,” I think that will feed that kind of panic mentality. I’m really concerned about inflation, wage inflation. It’s a good thing for the average worker, but it’s not a good thing for the economy. And then, finally, this — and this is an unbelievable story. I spoke to a client on Friday who said his father put $100,000 in Bitcoin, and it’s now worth $4 million — if that isn’t a speculative bubble.
Hedtke: I’m going to take the Bitcoin, though, a little bit in a different direction, but the speculative point is the same, and it goes back to what I was saying a little bit earlier. We see so much money, whether it’s in the real estate markets or it’s in some of these more illiquid places, private equity. You see so much money-chasing. And so that for me it’s a concern. There’s going to be pain somewhere along the way. That concerns me. And the European Central Bank for sure concerns me. And then China has been a huge leverage issue, whether it’s with corporations or it’s with the property market. Those are kind of the things — they’re there and they all concern me. Again, I generally think we probably continue on without anything really breaking here, but, boy, I think people should find some protection sometime soon, because I think that the risks are pretty substantial that are out there.
Erickson: When we’ve been monitoring the underlying indicators of economic health here in the U.S., one important metric is slowing. So if you look at the percentage change in total consumer debt growth, that has been slowing. So it’s not precipitous, but that is another thing. If consumer spending at the end of the day slows down, it’s two-thirds of the economy. That could be a problem.
What impact could Bitcoin have on everyday investors?
Erickson: If you go back and look at the capital markets’ history, there are other things that have gone through phases like this, and they kind of settled out and actually became a legitimate investment. We wouldn’t advocate rushing out and investing in it now, we don’t think it’s a viable asset class or investment, but don’t write it off for the longer term.
Paulsen: Right now I don’t think it’s big enough to cause much harm. If it were to crack tomorrow, it would be a really great media story and all, and we’ll find the person who lost a lot of money, but I don’t think it has a lot of legs for the rest of the economy. That won’t be the case in a few years, if it lasts.
Johnson: I think Bitcoin is going to have its place. Have they gone parabolic based upon a chart? Absolutely they have. But now you’re putting futures around them. You may bracket these things, and you may see instead of a bigger correction that people are hoping for, it ends up becoming stabilized and consolidates sideways for a while. So you may end up bringing these things in, and more of a stable price environment gets put around it, but it really is people looking for an evolution of money in exchange outside of the traditional norms. And the U.S. needs to either get on board with it — because every country outside of the U.S. is adopting it in a very big way, Australia, Japan, you name it.
Are there other alternative investments or investment ideas that are attractive right now?
Schleif: We look at different parts of the capital structure as well, and like real assets — timber and real estate, things like that — there’s different ways to play them. The hard part is for the average investor, because you really have to do your due diligence. You can’t just buy anything in that market, or you have to hire someone who will help you do really good, intensive due diligence on that.
Hedtke: It’s not really alternatives in the traditional sense, but one area we’re thinking about looking at with a different lens is more of this environmental social governance type of investing. There are some options out there for investors today. If you just think about where we’re at in society in what we’re favoring, I think there’s a real good long-term opportunity there.
Johnson: Some of the best relative performance has occurred in the industrials. So if you think back about cycles and business cycles, when your industrials typically lead, it suggests that we’re toward the mid-part of a business cycle. And in the latter part of a business cycle, commodities come into play. I would think commodities could have a decent year in 2018. Oil prices seem like they’re at a point where you could break out. A move above about $60 would suggest a move to maybe $70, $72.
Sit: I think going forward you have to look for quality stocks that are unit growers. And I don’t want to categorize them as growth stocks vs. value stocks, because you can have cyclical stocks that at an appropriate time in their cycle are unit growers. And when I say unit growers, I mean sales are improving, maybe you get some pricing off of that, they’re efficiently run companies, so you get the margin expansion, and that all leads to earnings per share growth. That’s what I mean by unit growers.
Henneman: Well, we like Minnesota. Minnesota hasn’t fully participated in this rally. It’s up about 10 percent vs. the market up 20 percent, and it’s created some nice opportunities. You wouldn’t expect the stable Minnesota companies to perform as well in such a hot market, and so we don’t think you need to go too far from a geographic standpoint outside of just our own state here.
What are your S&P 500 predictions for 2018?
Johnson: Let me back up and say 2,424 is what we had for this year, and then we made a course correction in August to make it 2,575. Now, for 2018, we’re looking for 2,850, which is a little less than 10 percent from where we are now. But I don’t think you’re going to get there in a straight line. You probably see this market go to maybe 3,000, and then you back up, and then you push harder into the year end.
Joy: We’re in a similar territory — 2,870 based upon our view that the economy grows quite well, somewhere around 2¾ percent, and that’s accompanied by roughly 10 percent earnings growth. But we think that the Fed is going to stick with its intended path, and that’s probably going to trim a little bit out of the valuation multiple, and so that gets us to where we are.
Hedtke: I’m not too much different. I’m at 2,850; 10-year Treasury note somewhere between 2½ and 3; and GDP at 2½. Generally, I think tax reform gives a little bit of cover for the Fed still, creating a little bit of upward bias on the short end, probably two moves is what we think. Again, those two moves being, if nothing else, to pad the buffers a little bit for if we were to have a downside. I do think the tail on the downside is getting a little thicker, so looking for areas of protection are important.
Lilly: I’m a little more cautious. I’m not a bear, but I think the market is going to go up a little bit next year, I would say around 2,800. I think that we’re long into this recovery, and there is now enough clouds on the horizon that are not market driven — because I think tax reform, Trump’s plan for infrastructure spending, all the things like that can really buoy the actual companies and consolidation with M&A. But I’m concerned about midterm elections. I think that that really is something that we have to watch carefully. And I think that the optimism about what Trump is going to truly be able to accomplish as the year goes on is going to wane, and so I’m cautious about what 2018 holds.
Henneman: I’ll take 2,700, expecting the economy to continue to grow up to 3 percent, 7 percent earnings growth, which will be met with higher interest rates, which are driven by inflation, which is driven by wage increases. Not that I’m concerned about the market. I wouldn’t trim the market here unless it is to rebalance a portfolio. There’s plenty of opportunities to find ways to beat that market going forward, if you do the fundamental work and watch valuations.
Paulsen: I’ll go 2,450 to win this year. I’m not saying it can’t go up from here, it probably will a little bit, but I just think we’re going to have a pretty good sell-off this year at some point. Not a bear market, but a good punch in the gut that scares the living daylights out of all of us, a lot of recession forecasts and then it will be a whale of a buying opportunity. And I think it will be driven by moving inflation and rate structures above 3 percent.
Sit: I’m going to say 2,900. I guess I’m the bull on the street here — I don’t see a recession on the horizon. The consensus earnings growth for this upcoming year is 11½ percent. Those numbers tend to be too high by 10 to 20 percent, so I shaved some off there and come up with 2,900. It’s going to be driven by fundamentals vs. multiple expansion, and if we get that kind of earnings growth, hopefully it will be a broader market, and 2,900 is doable.
Erickson: So our base case is in the more conservative range of everybody else, coming in at 2,825, and it’s based on multiples being about the same at 19.5 times earnings, and then earnings of about 145. We actually have an upside forecast, so I’m going to top Roger. We do think actually if tax reform goes through that we could actually be in the zone of 3,000, and the reason why is even though multiples might decrease a little bit — because the likely uptick in inflation and interest rates, even if we bring down the multiple to 19, we think we could get another $10 on earnings at 155. So that would actually put us in the 3,000 zone.
Schleif: I’ll go with 2,785 for domestic markets. We’re looking for stronger, better performing markets, developed markets around the globe, so better than a 5 percent increase looking outside the U.S., primarily because we do see a lot of potential for volatility. We wouldn’t at all be surprised to see a sharp pullback. But if we did that, we don’t think it indicates recession if policy moves don’t get in the way. We do think the Fed will move three or four times next year, and we are calling for the 10-year to be 2½ to 3 percent. And if you get up toward the 3 percent side of that, you are going to have a lot of other factors to watch in the U.S. That makes the U.S. tough to watch. And, again, midterm elections, interest rates, potential inflation pressures, and so we think there’s a lot of things that could lead investors to more volatility in the markets. Volatility isn’t a bad thing. People put it in as being risk, but volatility really can represent a lot of opportunity, like everyone said here today.
Patrick Kennedy • 612-673-7926