Outlook for 2018 is bullish, but risks remain: Strategist


Pending recessions typically end bull markets. And recessions are often presaged by certain signals: rising jobless claims; falling home sales; an inverted yield curve; wage pressures that impact corporate margins; exogenous shocks, including oil spikes; or destabilizing valuations in key asset classes.

We don’t see those red flags on the horizon as we enter the new year, so we continue to believe that 2018 will witness strong U.S. and global GDP growth. Equity gains will likely moderate from 2017, but we continue to favor stocks over bonds.

This is not to say that there aren’t risks being 100 percent invested in beta exposures 100 percent of the time. In fact, we are looking to lower our beta exposures in certain areas of global equity markets. For instance, the technology and momentum trade is getting long in the tooth.

Momentum as a factor tends to do well late in the cycle, when folks don’t have a better idea than to buy what has already gone up in the expectation that someone will be there to pay more for it in the future. Now is the time, in our view, as valuations become stretched, to begin balancing out one’s factor exposures; the next large drawdown will likely create an opportunity to bank some alpha relative to traditional beta exposures.

We continue to believe that investors should tilt their U.S. equity allocations toward large-cap quality. We feel this provides the best trade-off in terms of valuations, shareholder yield, growth expectations and the potential to buffer some of the downside if markets sell off.

The dollar weakened by 8.5 percent in 2017, creating a tailwind for the technology sector and certain multinational companies that should benefit from lower tax rates on the repatriation of foreign profits. The WisdomTree U.S. Quality Dividend Growth Index, for example, beat the S&P 500 Index by more than 550 basis points in 2017, and we continue to prefer the company and sector tilts within this Index relative to the broader market.

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In the developed world outside the United States, we continue to see opportunities in Japan. We expect to see a continuation of synchronous global growth in 2018, which is typically good for Japanese companies. If continued U.S. small-business and consumer confidence leads to a tighter U.S. labor market, we could see upward pressure on long-term yields in the United States. If Japan’s central bank continues to suppress 10-year yields in Japan, that could lead to further yen weakness, which would be good for their exporters. For these reasons, we continue to favor Japanese equities.

We also remain positive on emerging market equities. Although broad emerging market indexes have rallied 70 percent from their lows in January 2016, we still believe the asset class offers compelling value on both an absolute and relative basis. We continue to like companies that are freer to compete globally, thus favoring exposures that exclude state-owned enterprises.

On the fixed-income front, it is difficult to find sectors we would consider inexpensive. The rally in risk assets has tightened credit spreads considerably, and the much flatter yield curve presents diminished prospects for extending duration. Fixed-income investors should be realistic in expecting this to be a year of relatively low returns across asset classes in general — a year in which small ball becomes much more important than swinging for the fences.

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