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<\/p>\nThe market finished the year strong behind continued economic strength, low interest rates, and a passed tax cut.\u00a0 Telecom and energy were the worst performing sectors for the year, but performed the best during December, writes Ketu Desai.<\/b><\/p>\n
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In general, in December, investors sold the best performing sectors for the year, in favor of underperforming sectors. Traditional retail names worked great over recent weeks, as retail sales rose 5%, the highest growth rate since 2011.<\/p>\n
On the flip side, investors took profit on tech names.\u00a0 Optimism on the global economy and a weaker dollar helped emerging markets and oil rally.\u00a0 Gold finished the year with its best since 2010. The Federal Reserve raised rates during the month, but it was widely expected, and was treated as a non-event in the market.<\/p>\n
As we enter the new year, the global economic picture appears to be strong.\u00a0 The global economy is growing at its fastest pace since 2011. In 2018, most expect the global economy to grow between 3.5% and 4%.\u00a0 The growth appears to be broad based, as all 45 countries tracked by OECD are expected to grow.\u00a0 Even countries such as Brazil and Japan, that have struggled are expected to grow at significantly higher rates than in recent history.\u00a0 India and China are expected to grow 7.5% and 6.5%, respectively.\u00a0 Europe also appears to have stabilized, and is now showing levels of PMI, confidence, and manufacturing activity that have not been seen in years.\u00a0 Domestically, we have had two consecutive quarters of 3%+ growth, and are on track for Q4 growth of 2.8% according to the Atlanta Fed.\u00a0 For 2018, the U.S. is expected to grow 2.5%.\u00a0 However, there is some risk to the upside.\u00a0 Take a look at these passages from FedEx and Paychex earnings transcripts from late December.\u00a0 As you will see, growth and earnings estimates could get revised up, as companies adjust to the new rules, and potentially pull investment forward.<\/p>\n
FedEx:<\/b><\/p>\n
\u201cPassage of U.S. tax reform could add materially to next year\u2019s U.S. GDP forecast. Globally, our world GDP forecast for this year and the next reflects the best growth since 2011 with a synchronized global upturn supporting trade volume growth.\u201d<\/p>\n
On Capital Expenditures:<\/b><\/p>\n
\u201cSo, we have a couple of other questions here on CapEx and expensing, and the part that is often missed in the conversation because of the politics involved in this situation is if the tax bill works as anticipated, there will be a significant growth in GDP.<\/p>\n
And remember that the Business Roundtable did in a survey prior to this tax bill passing and 82% of the BRT membership anticipated that if it did pass that it would substantially increase their capital expenditures, and 75% anticipated that they would increase employment. Well, they\u2019re not making additional CapEx and increasing employment for any other reason than the market is growing.<\/p>\n
So, if we increase capital expenditures, as Alan said, it will be because the market is growing. We think we can make more money and increase cash flows and so forth. But there\u2019s not just any willy-nilly interest in increasing CapEx other than for that except for one thing. In the case of expensing, you increase the net present value of the returns if it is a replacement piece of capital because you get in, in place earlier and you get your money right back.<\/p>\n
So, to that extent, it would be bringing the money forward and not spending it later. It\u2019s the CapEx for GDP growth rates induced by the tax rate that is the important part of any increase in CapEx.\u201d<\/p>\n
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Paychex:<\/b><\/p>\n
\u201cLet\u2019s look at the guidance for 2018. It\u2019s unchanged from what we\u2019ve provided last quarter. This guidance doesn\u2019t reflect any impact from tax reform legislation. What we try to do in both the press release and you will hear in a second is supreme, what we think the ongoing benefit from tax reform will be for us\u2026We anticipated (the benefit) to be in the range of 10% to 12% on our annualized effective income tax rate.\u201d<\/p>\n
On Capital Expenditures:<\/b><\/p>\n
\u201cThere are some technology investments that could be made over the next, this fiscal, next fiscal, that while you\u2019re getting the biggest benefit of tax reform that we could accelerate those investments to maybe speed that up.\u201d<\/p>\n
Goldman Sachs expects the plan to boost growth by\u00a00.3 percentage points\u00a0in both 2018 and in 2019.\u00a0 If growth does continue, the risk then becomes inflation and faster rate increases.\u00a0 Forecasts for Fed rate hikes for 2018 range from 2 to 4, despite inflation being muted, core PCE is up just 1.5% on a year over year basis.\u00a0 However, there are signs of wage pressure, which would boost inflation.\u00a0 One of the key reasons for higher than average equity valuations, has been the low level of interest rates, and the relative attractiveness of equities, and if we start to see inflation and higher rates, then the attractiveness of equites begins to be questioned.<\/p>\n
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Equity Risk Premium:<\/b><\/p>\n
Source: i-squared research<\/i><\/p>\n
As the graph above shows, if rates increase, bonds increase their attractiveness to equities.\u00a0 Further, as rates increase, we could see multiple compression.\u00a0 With the tax cuts now passed, it is likely that 2018 S&P earnings will be in the $150s, the multiple applied makes a big difference in returns, and rates are a key determinant of the multiple.\u00a0 Multiple compression of a turn or two, could mean the difference between a respectable year and a down year.\u00a0 If rates spike, it will also cause repricing in other asset classes such as gold, currencies, emerging markets, and high-yield.\u00a0 As we all wonder, how long the good-times will last, rates and inflation are key fundamental indicators to keep a close eye on.<\/p>\n
S&P 500 2018 Returns:<\/b><\/p>\n
Source: i-squared research<\/i><\/p>\n
Interested readers can reach Ketu Desai by email <\/i>ketu@isquaredwealth.com<\/i><\/a>.\u00a0<\/i><\/p>\n","protected":false},"excerpt":{"rendered":" The market finished the year strong behind continued economic strength, low interest rates, and a passed tax cut.\u00a0 Telecom and energy were the worst performing sectors for the year, but performed the best during December, writes Ketu Desai. In general, in December, investors sold the best performing sectors for the year, in favor of underperforming…<\/p>\n