The stock market will rise another 15% next year! No, wait, it’s dropping 5%, at least if President Donald Trump’s tax cut never passes. It’s the time of year to digest more than just turkey: Nearly every bank on Wall Street has a new forecast for the stock market in 2018, and if they seem like a blur that’s because they collectively are one.
But each has its pluses and minuses — ideas that pass the smell test, others a touch rank. Most strategists think the Standard & Poor’s 500 index SPX, -0.07% has another 10% or so to rise after a 17% gain so far this year. But in looking at their reports, there’s also a palpable sense of experts keeping one eye on the exit, just in case.
Also read: Birinyi lifts his S&P target
The good news: Nothing looks as dumb as Royal Bank of Scotland’s advice to “sell nearly everything” heading into 2016, warning of a “fairly cataclysmic year ahead.” (The S&P returned 12%, and began a still-running, record-long rise without a correction by February). The bad news: RBS’s misadventure underscores that market forecasting is more art than science.
The argument: U.S. markets are in the middle innings of a 20-year bull run, BMO Capital Markets strategist Brian Belski argues. He’s calling for a 2950 S&P by the end of 2018, thanks to 11% earnings growth and valuations (specifically, price-to-earnings ratios) that ease only slightly off this year’s near-historic peaks. The key to that call is interest rates not moving up much.
Strongest point: Realistic fundamental expectations — BMO’s earnings forecast is close to consensus.
Weakest point: Belski’s argument relies on valuations staying near where they are as the Federal Reserve at least tries to raise interest rates.
Also read: 4 reasons the global bull market can run for years
The (Relative) Pessimist
This year was too good to repeat, is Morgan Stanley strategist Michael Wilson’s argument: He sees the S&P rising to 2750 in 2018. And he thinks it’s a good time to sell some U.S. corporate bonds, whose valuations have been stretched by persistently low interest rates.
Wilson’s argument turns on the idea that the U.S. expansion is getting old, and earnings growth will begin to fade after the first half of next year. The recession isn’t here yet, and not all the signs of overoptimism that show up late in bull markets are present, he says — but they’re close.
“We do not think [earnings per share] growth in 2019 will be that exciting and could even be negative,” Wilson writes. “Undoubtedly, that will matter for stock prices next year.”
Strongest point: Expansions do end sometime.
Weak point: Most economists don’t see that happening within 12 months, or even 20, given the absence of speculative bubbles (the bitcoin market is too small to matter)..
The (Prestigious) Fence Straddler
Goldman Sachs’s David Kostin has to reconcile the bullishness of Goldman’s economists and worries that the market is too expensive. His answer: The market may fall 5% if Congress doesn’t cut corporate taxes, but otherwise it should rise 11%, with the S&P reaching 2850. He thinks corporate earnings will rise 14% with a tax cut and 9.2% without one.
Strong point: Kostin points out that most stock gains since 2010 have come from improved profits, with 30% from higher valuations. In 1996-2000’s bull market, half the gains reflected higher price-to-earnings ratios, Kostin says. In that light, 2850 next year is “rational exuberance,” Kostin writes.
Weak point: He sees a modest further expansion of stock multiples he acknowledges are historically high.
The Truth, According to Me:
The likeliest 2018 outcome is sustained U.S. economic growth, begetting pretty-good profits and an opportunity for stocks to rise. That’s especially so because there are still reasons to be skeptical that inflation will surge, or that interest rates will rise enough to hurt stock multiples much.
The economy has plenty of capacity to deploy before being stretched. Even leaving aside Baby Boomers retired since 2008, there are still about a million fewer people in the post-recession workforce than there ought to be. The re-entry of some of those workers should limit wage demands, and recent gains in business investment may help productivity growth, containing inflation expectations. Moody’s Analytics economist Adam Ozimek says 3% employment-cost growth, which scares most strategists, could still be two to three years out.
But earnings growth effectively limits how much an expensive market like this one can rise. It’s smart to assume price-to-earnings multiples will moderate by late 2018, because the end of this already-long expansion will be 12 months closer.
Add it up, and you get 10% profit growth and a dip in price-to-earnings ratios — small, because next fall there still shouldn’t be a recession in sight. Put me down for a 5% jump to a 2730 S&P 500, a 7% gain including dividends. If I bet on that being too high or too low, I’d take the over.