Thus far, 2017 has been good to investors, particularly to equity investors, and stock market returns are reflecting an increasingly positive outlook for economic growth and corporate profits in the U.S. market. Globally equity markets have also been strong, with emerging markets, as represented by the MSCI Emerging Markets Index, returning a robust 28.1% year-to-date. Over the three and five-year periods, U.S. stocks, as represented by the S&P 500, led the charge, returning 10.8% and 14.2%, respectively. However, in 2017, although U.S. equities returned a strong 14.2%, they nonetheless lagged both the emerging and developed international markets (MSCI EAFE).
In our view, the U.S. economy will continue on a path of solid growth. This year’s violent hurricane season will distort economic data in the short term, but underlying trends in the economy remain firmly established and we anticipate slow but steady growth into 2018.
Much of the growth in the U.S. economy is being driven by accelerating growth internationally. The J.P. Morgan Global Manufacturing PMI (Purchasing Manager’s Index), which serves as a broad measure of industrial activity around the world, has shown the global economy undergoing an expansionary period with industrial activity accelerating in most of the world this year.
Following the Great Recession, most of the economic improvement in Europe was centered on Germany. Recently though, growth has been accelerating throughout Europe. This growth underpins the surge in profitability exhibited by European companies. Japan has also seen an uptick in economic activity and with the re-election of Prime Minister Abe, we expect there to be continued focus on economic stimulus
Strengthening in the international economy will likely continue to reinforce expansion in the U.S. economy. In our view, the risk of recession over the next year is low. The Federal Reserve Banks of Atlanta and St. Louis support this view, as their models forecast the likelihood of recession at less than 10% through Q3 2018. Inflation continues to be low, but we could see an uptick as full employment in the U.S. and excess capacity are absorbed internationally. However, relatively low inflation and solid growth should persist internationally, particularly in Europe and Japan
In politics, the conversation has turned to tax reform. The White House and congressional GOP leadership have put forward a tax package, but in our view the probability of real tax reform is not high. Rather we anticipate that what will emerge from the legislative process will be more of a tax cut plan. In our view, the tax package has about a 50/50 chance of passing, with Q1 2018 as the most likely timeframe. Tax cuts would likely have a slightly stimulative effect on the overall economy, but won’t show up in corporate profits until later in 2018 and 2019.
Over the past year, declining bond yields and well-rewarded credit risk have had a positive impact on fixed income returns across the quality spectrum. This fall’s vicious hurricane season is expected to have a negative impact on municipal bonds, particularly as many of the communities hardest hit have significant amounts of municipal debt. Houston and Florida should benefit from state and federal support, as well as relatively strong local economies. Puerto Rico, on the other hand, given its already compromised position, is likely to face a significant degree of credit fallout.
The outlook for corporate profits remains positive in the U.S., and global growth, as well as currency effects, should continue to provide a tailwind for profits in future quarters. Much of the expansion in valuations over the past year has come on the back of expectations about tax reform. If the proposed reduction in the corporate tax rate, from 35% to 20%, comes to fruition, corporate profits could see a very meaningful boost. However, the results on the tax front are far from assured.
For more on our outlook for the markets in the fourth quarter and beyond, please have a look at our CIBC Atlantic Trust Private Wealth Management Fourth Quarter Financial Markets Monitor.
You can also speak to your CIBC wealth advisor for more market insights and advice.
Bill Norris is chief investment officer and head of asset management for CIBC Bank USA. In this role, he oversees investment management, trust and estate services to individual and institutional clients of CIBC Bank USA. Bill also serves as a member of CIBC Atlantic Trust Private Wealth Management’s Asset Allocation Committee.
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