The 2018 Outlook: An Aging Expansion & Bull Market · The 2018 Outlook: An Aging Expansion & Bull...

This data is provided for information only and is not intended for trading purposes.

The 2018 Outlook:

An Aging Expansion & Bull Market Mark Keller

December 2017


The Base Case

No Recession in 2018

─ Real GDP +2.25%, core PCE remains under 2.0%

S&P 500 of 2739.20

─ Earnings of $129.82

─ P/E of 21.1x

─ Potential to exceed this forecast

10-year Treasury range of 2.25% to 2.50%

─ 3 rate hikes this year

2


The Economy

Growth Continues

This data is provided for information only and is not intended for trading purposes. 4

Source: NBER, CIM


-4

-3

-2

-1

0

1

2

-4

-3

-2

-1

0

1

2

70 75 80 85 90 95 00 05 10 15

CFNAI, 6-mo Avg Recession Point

CHICAGO FED NATIONAL ACTIVITY INDEX

IND

EX

Sources: Chicago FRB, CIM

Current Reading=+0.052


-1

0

1

2

3

4

5

6

NET EXPORTS GOVERNMENT

INVESTMENT FIXED INVESTMENT

CONSUMPTION GDP

AVERAGE CONTRIBUTION TO REAL

GDP DURING EXPANSIONS

1960-69 1971-73 1975-80 1980-81 1983-90

% O

F G

DP

GR

OW

TH

1991-00 2002-07 2009-16

Sources: Haver Analytics, CIM


-4

0

4

8

12

16

20

45 50 55 60 65 70 75 80 85 90 95 00 05 10 15 20

CONSUMER PRICE INDEX10.0% 3.0%1.1%1.5% 4.5% 8.0%11.4%2.4% 3.7% 2.8% 2.7% 1.6%



-60

-40

-20

0

20

40

60

-60

-40

-20

0

20

40

60

70 75 80 85 90 95 00 05 10 15

PHILADELPHIA FED

BUSINESS OUTLOOK INDEX

Source: Philadelphia FRB, CIM

CURRENT READING =

+23.40


80

84

88

92

96

100

104

108

86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18

NFIB SMALL BUSINESS OPTIMISM

IND

EX

Sources: Bloomberg, CIM

10


Risks to the Expansion

Tightening Monetary Policy,

Fiscal Expansion, Geopolitical Risk


-4

-2

0

2

4

6

8

10

12

88 90 92 94 96 98 00 02 04 06 08 10 12 14 16

MANKIW USING EMPLOYMENT/POPULATION

MANKIW USING UNEMPLOYMENT RATE

MANKIW USING PART TIME AS % OF LABOR FORCE

MANKIW USING Y/Y% WAGE CHG FOR NON-SUPERVISORY WORKERS

TARGET

MANKIW RULE(CIM VARIATION)

MANKIW WITH EMPLOYMENT/POPULATION = 0.89%

MANKIW WITH PART TIME = 2.67%

MANKIW WITH UNEMPLOYMENT RATE = 3.18%

MANKIW WITH WAGES = 0.94%

Sources: Greg Mankiw, Haver Analytics, CIM

FED

FU

ND

S


0

2

4

6

8

10

-1

0

1

2

3

4

5

90 92 94 96 98 00 02 04 06 08 10 12 14 16 18

IMPLIED LIBOR RATE, 2-YEARS OUT

FED FUNDS TARGET

IMPLIED LIBOR RATE LESS FED FUNDS

FED FUNDS AND IMPLIED LIBOR RATES

SP

RE

ADR

AT

E

Sources: FRED, Bloomberg, CIM


all 2017 2018 2018 New

Yellen 3 3 3 Powell 3

vacant 3 3 El Erian 3

Brainard 4 4 4 Brainard 4

Powell 3 3 3 Taylor 1

Quarles 2 2 2 Quarles 2

vacant Goodfriend 2

vacant vacant

Dudley 3 3 3 Dudley 3

Evans 4 4 Evans

Bullard 5 Bullard

George 1 George

Mullinix 1 1 Barkin 2

Bostic 3 3 Bostic 3

Williams 2 2 Williams 2

Mester 2 2 Mester 2

Rosengren 2 Rosengren

Kashkari 5 5 Kashkari

Kaplan 3 3 Kaplan

Harker 2 2 Harker

2.81 3.20 2.60 2.45


-4

-3

-2

-1

0

10

2

4

6

8

10

88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18

CFNAI, 6-mo Avg FED FUNDS TARGET

FED FUNDS TARGET AND

THE CHICAGO FRB NATIONAL ACTIVITY INDEX

FED FU

ND

S TARG

ETC

FNAI

Sources: Chicago FRB, Haver Analytics, CIM


-15

-10

-5

0

5

10

15

1950 1960 1970 1980 1990 2000 2010

PRIVATE GOVERNMENT FOREIGN

NET SAVINGS BALANCES

% G

DP

% G

DP

Sources: FRB, CIM


Geopolitical Risks

The Waning U.S. Superpower Role

Chinese Deleveraging

European Politics

─ Italian Elections

─ PM Corbyn?

2nd Korean War

South American Populism

─ Populists polling well in Brazil, Mexico

Middle East Turmoil

U.S. Domestic Politics

─ 2018 Mid-terms 18


Equities

Modest Earnings Growth, High Multiples


Equities

S&P 500 of 2739.20

─ Earnings of $129.82

─ P/E of 21.1x

─ Potential to exceed this forecast

Growth outpaces Value

Moderate bias toward foreign

20


0.9

1.0

1.1

1.2

1.3

1.4

20

40

60

80

100

120

140

94 96 98 00 02 04 06 08 10 12 14 16

THOMSON/S&P OPERATING EARNINGS RATIO

THOMSON-REUTERS OPERATING EARNINGS (4Q ROLLING)

S&P OPERATING EARNINGS (4Q ROLLING)

RATIO, THOMPSON-REUTERS, S&P

OPERATING EARNINGS

RA

TIO

, TH

OM

SO

N-R

EU

TER

S/S

&P

Sources: Haver Analytics, Bloomberg, CIM

OP

ER

ATIN

G E

AR

NIN

GS

,

RO

LLING

4Q


200.0

20.0

2.0

0.2

20 30 40 50 60 70 80 90 00 10

4Q TRAILING GDP EARNINGS FORECASTBOTTOM TOP

EARNINGS AND GDP

4-Q

RO

LLIN

G E

ARNI

NGS,

LOG

SCA

LE

Sources: Haver Analytics, Philadelphia FRB, I/B/E/S, CIM

GREEN AREA =

FORECAST


-1

0

1

2

3

4

5

6

7

96 98 00 02 04 06 08 10 12 14 16 18

S&P EARNINGS/GDP FORECAST

MARGIN MODEL

RATI

O

Sources: Haver Analytics, Philadelphia Fed, CIM


-8

-4

0

4

8

0

5

10

15

20

25

30

60 65 70 75 80 85 90 95 00 05 10 15

DEVIATION 4Q TRAILING P/E FAIR VALUE

P/E MODEL(35-54 Age Cohort, AAA bond yield, consumer sentiment, fed funds, trend CPI)

P/E

DE

VIA

TIO

N



-15

-10

-5

0

5

10

15

5

10

15

20

25

30

50 55 60 65 70 75 80 85 90 95 00 05 10 15

DIFFERENCE P/E (4-Q TRAILING) RULE P/E

RULE OF 20(20-CPI)

P/E


DIF

FE

RE

NC

E


0

4

8

12

16

0

5

10

15

20

25

30

90 00 10 20 30 40 50 60 70 80 90 00 10 20

4Q TRAILING P/E

ROLLING 5-YR STANDARD DEVIATION OF CPI

TRAILING P/E WITH CPI DEVIATION LINES

Sources: Robert Shiller, Haver Analytics, CIM

P/E

& C

PI


1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

S&P (LOG) TRENDLINE +1.0 ST DEV +0.5 ST DEV

+2.0 ST DEV -1.0 ST DEV -0.5 ST DEV -2.0 ST DEV

LONG-TERM S&P TREND

LO

G S

CA

LE


5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20

S&P (LOG) TRENDLINE +1.0 ST DEV +0.5 ST DEV

+2.0 ST DEV -1.0 ST DEV -0.5 ST DEV -2.0 ST DEV

LONG-TERM S&P TREND

LO

G S

CA

LE


Year-end +0.5 Stdev = 2733.37

2018 +1.0 Stdev = 3300.93


0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

70 75 80 85 90 95 00 05 10 15

D-MARK PARITY

EURO PPP MODEL

$ P

ER

DM

95%

95%

66%

66%

EURO FAIR VALUE = $1.3012

Sources: OECD, BLS, FRB, CIM

98%

98%

0.8

1.2

1.6

2.0

2.4

2.8

3.2

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

$/£ EXCHANGE RATE PPP FAIR VALUE

GBP PPP MODEL

PARITY = $1.6317

US

D P

ER

GB

P


0.6

0.8

1.0

1.2

1.4

1.6

1.8

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

CAD PER USD PARITY: C$1.1335

CANADIAN PPP MODEL

CA

D P

ER

US

D


-100

0

100

200

300

400

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Yen per dollar Parity

YEN PPP MODEL

PARITY = 58.96 ¥/$



Fixed Income

Mostly Steady Rates


-3

-2

-1

0

1

2

3

0

4

8

12

16

60 65 70 75 80 85 90 95 00 05 10 15

DEVIATION10-YR CONSTANT MATURITY YIELD

FAIR VALUE

TEN-YEAR T-NOTE MODEL

%D

EV

IATI

ON

FAIR VALUE RATE =

2.26%


(WITH YEN, OIL PRICES & GERMAN BONDS)


0

2

4

6

8

0

4

8

12

16

20

30 40 50 60 70 80 90 00 10

BAA-T-NOTE SPREAD BAA-T-NOTE AVERAGE

-1 STANDARD DEVIATION +1 STANDARD DEVIATION

10-YR T-NOTE YLD BAA YIELD

T-NOTE/Baa CORPORATES

Sources: Haver Analytics, FRB, CIM


0

5

10

15

20

25

0

5

10

15

20

25

88 90 92 94 96 98 00 02 04 06 08 10 12 14 16

AVERAGE SPREAD

HIGH YIELD LESS 5-YR CONSTANT MATURITY T-NOTE

BofA ML HIGH YIELD MASTER II (EFFECTIVE)

5 YR TREASURY

HIGH YIELD SPREADS

YIELDS

SPR

EAD

Sources: Haver Analytics, FRED, CIM


We look for another good year for financial assets and the economy

─ However, risks of a policy error or a geopolitical event are rising

─ The risks will be higher in 2019

This will be a “stay tuned” year

─ We may see increasing volatility as the mid-term elections near

34

In Conclusion


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314-743-5090

www.confluenceinvestment.com Twitter: @ConfluenceIM

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