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2018 Mid-Year Outlook: Later, tighter and still volatile

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11 months 2 weeks
Submitted by mark.mcdermott on Wed, 07/11/2018 - 14:04
2018 mid-year outlook: Later, tighter and still volatile

What changes will the rest of 2018 bring to the investment landscape? Get perspectives from the Schwab Center for Financial Research to help inform your client conversations.

What a ride it has been. We swept into 2018 on a surging tide of economic growth and strengthening corporate earnings. Investors were giddy. The recently enacted tax cut added to the exuberance, just as the global economy more broadly looked set for another year of strength. The Dow Jones Industrial Average and broader S&P 500® Index each added more than 2,000 points in the first couple weeks of January.

But the high spirits didn't make it through the month.

Concerns about inflation crashed the party at the end of January, knocking at least 10% off of the major stock indexes. We've bounced higher and fallen again over the ensuing months. Concerns about trade and short-term scares related to geopolitical surprises have also taken a toll. The bull market has been stuck in correction territory ever since—and will remain there until it can get back to those January highs. 

All this has happened against a backdrop of tightening monetary conditions as the Federal Reserve (Fed) has been raising interest rates and reversed the extraordinary bond-buying program it kicked off to help fight the financial crisis. Now, the Fed is no longer reinvesting the proceeds when the bonds on its balance sheet mature, leaving the market to soak up all the bonds the Fed is no longer buying. Tightening monetary conditions have typically added to market volatility. 

So where does all this leave us as we stare down the back half of the year? In much the same place: Caught between the tailwinds of strong economic and solid earnings growth and the headwinds of an uncertain trade situation and increasingly tight monetary conditions. Throw in the historical volatility around a midyear election, and it looks like investors would do well to keep their seatbelts fastened tight. 

Strong economy/active Fed

The current economic expansion is now officially the second-longest in the post-WWII era. While we believe that the U.S. has entered a late stage of this long business cycle, we don't see a recession on the horizon any time soon.

Growth figures for the second quarter aren't ready yet, but the Atlanta Fed's closely-watched GDPNow forecast is for a 4.1% expansion. The jobless rate is at historical lows—there are now more job openings than there are unemployed people—and inflation is finally picking up, with several different measures now near or above the Fed's 2% target rate.  

That means the Fed is likely to be more active the rest of this year than was expected at the start of 2018.

"We anticipate the Fed will hike rates two more times this year, given movement in both of the Fed's mandates—inflation and employment. Other global central banks—notably the European Central Bank—are also moving toward policy normalization, which means the tide of global liquidity is receding," says Liz Ann Sonders, chief investment strategist at Schwab. "As they say, when the tide goes out, it's time to start looking for the naked swimmers."

So expect more volatility.

Outlook for U.S. stocks

We continue with our theme of "it's getting late" when looking ahead to the second half; with important and rising risks to weigh against the rewards. For more from Liz Ann Sonders, read Headwinds and tailwinds facing off.

Cartoon that shows the high hurdles which earnings growth faces in the near-to-medium term.

Global outlook

Global economic and earnings growth momentum is slowing, but still growing. How the ongoing trade conflicts develop pose a risk to markets the second half of the year. For more from Jeffrey Kleintop, read From sugar high to high tariffs?

Cartoon that shows how market moves around tariff implementation may change in the coming months.

Bond market outlook

We don't expect returns for investment-grade corporate bonds to be as poor in the second half of the year as they were in the first, but the markets are still challenging. For more from Kathy Jones, read Last one out, turn off the lights.

Cartoon that shows that the amount of excess global liquidity is likely to shrink.


To hear more from Schwab Center for Financial Research experts, visit Market & Investment Insights on the Schwab Advisor Services website.

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