January 3, 2018

After a weak start to the year, real GDP (Gross Domestic Product) increased only 1.2% in the first quarter of 2017, U.S. economic growth improved and looks to have increased close to 2.5% for the year as a whole.  The second and third quarters of the year showed gains of 3.1% and 3.2% respectively and the fourth quarter probably increased 2.5-3.0%.

We are in the ninth year of expansion and the longest period of sustained growth recorded was for the ten-year period from 1991-2001.  Even though the economy is mature in terms of duration, we believe another year of around 2.5% real GDP growth is possible in 2018 as job gains remain healthy, consumer and business confidence is high and financial conditions are easy.   Tax reform legislation approved by Congress and a synchronized recovery in the global economy should also contribute to growth and help to extend the cycle.  Provided inflation remains low and the Federal Reserve continues to increase interest rates very gradually, there is an opportunity for this economic cycle to set a record and extend beyond its ten year anniversary in June, 2019.

We also have to acknowledge, given its duration, the probability of the cycle ending.  While we believe the risk of recession is currently low, we will of course be closely monitoring fundamental developments as we approach upcoming economic milestones.


Although we are near peak stock market valuations and late in the economic cycle, synchronized global economic growth and low inflation remain supportive of share prices.  As long as inflation stays low, the Federal Reserve should be able to continue raising interest rates in a gradual and predictable manner, which will help extend economic growth and enable corporate profits to continue to advance.  Corporate profits will of course get an additional boost from the corporate tax cut approved by the Congress and will keep benefiting from the ongoing global expansion.   With low risk of recession, improving corporate profits, a better global economy, a gradual and predicable increase in interest rates by our Federal Reserve, and now beneficial tax reform legislation approved by Congress, the fundamental outlook for the market is favorable.

While the outlook is generally favorable, with both the stock and bond markets highly valued and a significant drawdown in share prices long overdue, we are sensitive to any developments that could cause the market to correct. The S&P 500 median price-to-earnings ratio is higher than 98% of historical periods and the median price-to-sales ratio is at the highest level in the data series.  The 10-year U.S. Treasury is highly valued too and offers only a 2.5% yield to maturity.  Also, since 1928, stock market pullbacks of 5% or greater have occurred on average three times per year.  It has now been 380 trading days without a 5% or greater pullback, the second longest streak since 1928.  We attribute the lack of volatility largely to very accommodative Central Bank policies throughout the developed world.  These policies will remain accommodative in 2018 as most Central Banks will further expand their balance sheets and keep interest rates very low.  However, there will be a reduced amount of balance sheet expansion in 2018 relative to 2017 by Central Banks, and it is estimated that roughly $1 trillion of less liquidity will be provided to the financial markets.  Our Federal Reserve has already begun a reduction of its balance sheet along with a gradual increase in interest rates.  With less abundant dollar liquidity available to the financial markets and stock markets highly valued and extended, it would not be surprising to see more stock market volatility in 2018 and an overdue drawdown in share prices sometime during the year.

We believe our Clients’ holdings are attractively valued on our work, will benefit from the ongoing global economic recovery, and are strong financially.  We think these attributes will prove to be rewarding for our Clients in an environment where the global economy is advancing, but where stock market valuations are high and the cost of doing business is increasing due to higher interest rates.