After a postelection year when the S&P 500 climbed 20% and the market’s top stocks did far better, investors may have to search farther for big returns in 2018.
X Since 1962, every time the S&P 500 rose more than 15%, it delivered a lower performance the next year. That said, money managers and strategists still see plenty of investment opportunities in 2018. But some of the best gains may come in overseas stock markets and in value equities both in the U.S. and abroad.
That rotation of big portfolios into more foreign stocks is expected to take place despite economic uncertainty due to the U.K.’s Brexit and escalating tensions with Russia’s Vladimir Putin and China’s Xi Jinping, not to mention North Korea’s nuclear threats.
Two big reasons are the prospect of faster economic growth abroad and cheaper valuations for many foreign equities. GDP growth will likely continue strong in both China and Europe, where European Central Bank (ECB) President Mario Draghi says monetary stimulus will continue until at least September.
The U.S. economy looks positive too. Investors are heartened by incoming Federal Reserve Chairman Jerome Powell, and they’re jazzed by a drum roll of moves by President Trump, including tax reform, opening the way for oil drilling in the Arctic National Wildlife Refuge, throttling back on federal regulations and withdrawing from the Paris climate accord.
But with many stocks up sharply from a year ago, investment strategists and fund managers expect more modest stock price gains in 2018. The S&P 500’s 2017 return was more than double the big-cap bogey’s 8.67% average annual gain over the past 10 years. The Nasdaq composite index shot up 29% and the Dow Jones industrials gained 26%.
Align Technology (ALGN), part of the Nasdaq and a member of the IBD 50 list of top-performing growth stocks, jumped 134% in 2017. The company is known for its computer-assisted design approach to straightening teeth.
Banking giant JPMorgan Chase (JPM), a cog in the Dow, rose 25% in 2017. IBD Markets Editor Juan Carlos Arancibia analyzes 2017’s top-performing stocks in a separate article.
Outlook For Foreign Stocks Vs. U.S. Stocks
Against this backdrop, money pros say some of the best opportunities lie in non-U.S. stocks. And in both the U.S. and abroad, they see good potential in value-oriented stocks, including cyclical stocks whose performance swings up and down with economic conditions.
“Stocks will be better than bonds once again in 2018,” said David Joy, chief market strategist for broker and financial advisor Ameriprise Financial (AMP). “And we like international markets better than domestic. That includes developed markets in the eurozone but not the U.K., and it includes Japan.”
Joy cites three reasons why foreign stocks may shine. “Economic growth relative to potential growth appears to be stronger in those international markets than in the U.S. even though the U.S. is doing well,” he said. “And central banks in those (foreign) geographies will be more accommodative than in the U.S., where the Federal Reserve as everyone knows is raising interest rates.”
The third reason: Valuations. U.S. stocks as a group have grown expensive, Joy says. Other markets are more attractively valued. So there’s more upside potential than in U.S. stocks overall.
But Joy added, “We do think U.S. stocks will go higher.” Ameriprise currently forecasts that the S&P 500 will hit 2865 in 2018, up nearly 7% from its current level below 2700.
U.S. Stock Market Predictions
Joseph Davis, Vanguard’s global chief economist and head of its investment strategy group, says Vanguard expects the lowest returns for U.S. equities in roughly a decade. His group expects 4% to 6% annual gains for U.S. stocks in the next five years.
Ameriprise forecasts 3.0% U.S. GDP growth in excess of inflation in 2018. Before Congress passed tax reform, Ameriprise was predicting 2.4%. China’s pace should remain around 6.5%. The eurozone’s economy should grow around 2.2% vs. 2.1% in 2017.
As for interest rates Ameriprise, among others, expects the Fed to continue raising rates. That “will be a lid on earnings multiples for U.S. corporations and may bring some (multiples) down,” Joy said. Research firm Action Economics sees the fed funds rate around 2.12% by the end of 2018, up from its 1.25% to 1.50% band since June 2017.
U.S. tax reform is a wild card. “It should add incrementally to earnings growth and economic growth,” Joy said. “It should provide a little tailwind to stocks.”
U.S. joblessness should drop to 3.6% by the end of 2018, the lowest rate since 1969, Ameriprise says. The unemployment rate was 4.1% in November 2017.
David Polak, equity investment specialist at Capital Group, the parent of American Funds, sees investment opportunities in several geographic markets. Asia and the U.S. remain leading sites of technology innovators, he says.
Technology Stocks To Watch
Manufacturers of logic chips are one group of innovators. Industry consolidation has left four key players, including Taiwan Semiconductor (TSM) and California-based Intel (INTC). Fifteen years ago, there were 25.
“Taiwan Semi and Intel are dominant,” Polak said. “Consolidation has left the space more disciplined, which should lead to more visibility of earnings and more pricing power.”
Another Asia stock he likes is Japan’s Murata Manufacturing. “Their ceramic capacitors are crucial components for smartphones, but relatively inexpensive, so manufacturers can stuff phones with them without impacting their margins much,” he said.
Since the capacitors are used in Apple iPhones as well as Samsung Galaxy and other Android phones, “It’s a way to invest in the growth element without having to bet on which phone will do better,” Polak said.
In gaming, he likes the way Japan’s Nintendo (NTDOY) has diversified its addressable market. “They took their intellectual property away from just hardware,” Polak said. “You used to have to play their games only on their hardware. Now it’s available on multiple devices.”
Then there’s Tencent (TCEHY), China’s leading provider of messaging and mobile gaming services. Tencent also owns the popular WeChat app.
For Polak, a key Tencent trait is its leadership in China’s mobile payments services, enabling consumers to use smartphones to pay bills and make online purchases.
IBD’S TAKE: Tencent is among the best Chinese stocks to buy and watch. When you’re looking to get a broader idea on top tech stocks, check out IBD’s Tech Leaders feature.
Peter Bourbeau, co-manager of $ 9.3 billion ClearBridge Large Cap Growth (SBLYX) sees opportunities among U.S. stocks but says it’s time to switch from FAANG stocks because their price run-ups have left less room to rise. The ClearBridge fund is on track to becoming a 2018 IBD Best Mutual Funds Award winner after outperforming the S&P 500 in 2017 as well as in the trailing three, five and 10 years.
Top Stocks To Watch In Other Industries
Schlumberger (SLB) should benefit from a bottoming among energy stocks, Bourbeau says. Oil and gas service companies have regained pricing power, he adds.
“SLB currently generates incremental margins of 60%-plus (the highest in its history) and is benefiting from its OneStim U.S. joint venture with Weatherford International (WFT) for pressure pumping,” he said. “SLB is the only global service company that is using its balance sheet to invest alongside its customers.”
Among health care stocks, Bourbeau likes Alexion Pharmaceuticals (ALXN). He calls it “a leader in ultrarare genetic disease treatments. The company recently cleared the decks with new management and a refocused research and development profile. Alexion also received additional approvals for its lead compound Soliris for (treating other maladies).” Solaris also was being tested for new ways of being administered.
Within the financial services stock group, he likes Visa (V). “Visa is making very good progress on its recent acquisition of Visa Europe with synergies and client engagement,” he said. “Although incremental margins are extremely strong, Visa continues to innovate within its core debit/credit portfolio as well as (creating) new ways to integrate with merchants and cardholders.”
Outlooks For Amazon And Microsoft
What about some of the big stocks that padded his mutual fund’s recent gains? FAANG stock Amazon (AMZN), up 57% in 2017, was among his top holdings as of Sept. 30. So was Microsoft (MSFT), which rose 38% for the year.
“Amazon continues to execute its plan of disrupting adjacent verticals and margin-rich opportunities,” Bourbeau said. “It continues to focus on marketplace, Amazon Web Services (AWS) and Prime. The company has a huge opportunity outside the U.S. and will focus on countries like India, which is more hospitable to Western technology companies. We still see a large opportunity in AWS as we are in early stages of a generational shift to how technology is created and consumed.”
Regarding Microsoft, Bourbeau said, “We expect more of the same strong growth trends for Microsoft as the software maker helps its clients move workloads to the cloud. Its Azure cloud business is at a $ 20 billion run rate (in sales for 2018) and growing double digits. The company continues to focus on partnerships with service providers and competing technology, a departure from the strategy of previous management.”
Celgene (CELG), another top holding, is an inexpensive stock, he said, adding that Celgene has a strategy for coping with the patent expiration of its flagship product, the cancer drug Revlimid, in the middle of the next decade. “The biotechnology company should have 19 late-stage clinical readouts in 2019,” he said. “Cash continues to build and we expect some business development opportunities or acquisitions to further bolster its clinical pipeline.”
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