US Stock Market Forecast for 2018
Sam Subramanian PhD, MBA
The US stock market has enjoyed significant gains in 2017. Investors are now worried about high valuation metrics and wonder how long the bull market will continue. What is AlphaProfit's US stock market forecast for 2018?
The US economy and the US stock market have had a good run in 2017.
The unemployment rate has declined to 4.1% from 4.7% at the start of the year.
The US gross domestic product has risen at an annual rate of over 3% in both the second and third quarters, the first such back-to-back gains since 2014.
For the first time in a decade, corporate earnings have benefited from synchronized global economic expansion.
Interest rates remain low against this backdrop.
The benchmark federal funds interest rate stands at 1.5% after starting the year at 0.75%.
Rising corporate earnings, low interest rates, lower corporate tax rates starting in 2018, and the promise of fewer regulations have helped stock prices rally in 2017 with low volatility.
S&P 500 has risen steadily through 2017 with abnormally low volatility.
Large-cap stocks have fared better than small-cap stocks with technology and industrial stocks leading the way.
Popular large-cap benchmarks, the S&P 500 and the Dow Jones Industrial Average are up 22.0% and 28.2%, respectively while the small-cap Russell 2000 benchmark is up only 14.7%.
The technology-heavy NASDAQ composite is up 34.5%.
US Stock Market Forecast for 2018: What's on Investors' and Analysts' Minds?
The US stock market is in the eighth year of the bullish phase that started in 2009.
The S&P 500 is up 377% since stocks bottomed on March 9, 2009.
Up 377% from its 2009 bottom, the S&P 500 is in the eighth year of the bull market.
According to FactSet, the 12-month forward price-to-earnings ratio for the S&P 500 stocks currently stands at 18.3. The P/E ratio has averaged 15.8 and 14.2 over the past 5 years and 10 years, respectively.
A recent survey conducted by State Street Global Advisors shows investors are most concerned with stretched valuation and continued longevity of the bull market.
On the earnings front, analysts currently expect S&P 500 companies to grow their earnings by 11.2% in 2018. Their expectations are supported by a lower corporate tax rate and prospects for continued deregulation in 2018.
Yet, double-digit earnings growth has often proved to be a high bar for S&P 500 companies to hurdle over. In fact, double-digit earnings growth has been more an exception than the norm.
The last time S&P 500 companies recorded double-digit earnings growth was in 2011.
US Stock Market Forecast for 2018: Earnings Growth and Valuation Implications
Stock prices typically rise when companies exceed earnings forecasts and decline when earnings fall short.
The years following the Great Recession, however, were an exception to this norm.
Coordinated quantitative easing programs pursued by global central banks supported stock prices and helped to extend the bull market over eight years.
Things are different today.
The Federal Reserve has now switched to a quantitative tightening mode and is gradually shrinking or 'normalizing' its balance sheet.
As such, stock prices are unlikely to be bailed out by growth in the Fed's bank balance sheet in 2018 if earnings fail to live up to high expectations.
High valuation metrics pose risks akin to high earnings growth expectations.
Historically, stock market returns tend to be lower when the starting forward 12-month P/E ratio is elevated.
Going into 2018, the forward 12-month P/E ratio is already elevated. This leaves little room for the forward 12-month P/E ratio to increase in the event, US companies match or exceed earnings expectations.
So, what does this all mean for AlphaProfit's US stock market forecast for 2018?
US Stock Market Forecast for 2018: Bottom Line
Gains for the US stock market are likely to match the magnitude of growth in earnings if US companies match or exceed earnings expectations and valuation metrics remain flat. This scenario would imply a modest double-digit return, trailing the US stock market gain in 2017.
On the downside, disappointment in earnings growth can lead to a contraction in the forward 12-month P/E ratio. If this ratio returns to its 5-year average of 15.8, this by itself would cause US stock prices to decline 14% in 2018. The actual decline can, however, be mitigated by growth in earnings.
See Best Sectors for 2018.
AlphaProfit's Investment Recommendations
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