The past year was better than expected for investors. Edward Jones thinks the outlook is positive – but not quite as good as the recent past. That's why you may need to take off your rose-colored glasses so you can set realistic expectations and stay patient in 2018.
We think stocks can keep rising globally. Interest rates are likely to remain low, but volatility could return unexpectedly. As you prepare, consider the answers to these three important questions:
1. Will the global bull market continue? Some have worried about the length of this bull market. But improving global growth and rising corporate earnings are the food that we think will keep feeding this bull market and spur it higher. However, you should expect its pace to slow from a trot to a walk, with a few stumbles along the way.
Global stocks should continue to rise in 2018, and we expect international stocks to outperform U.S. stocks for the second year in a row. In the U.S., still-solid job growth and higher business investments should continue to support modest economic growth. And tax cuts should boost earnings, especially for smaller companies, which generally pay higher tax rates.
We think broadly diversified international stock investments are an opportunity. Their valuations are attractive, and we think they should continue to outperform, helped by stronger global growth and faster earnings growth.
In our view, large-cap U.S. stocks are still attractive despite above-average valuations. Add small- and mid-cap stocks if needed, since they lagged in 2017 and could outperform.
2. How much will interest rates rise? U.S. interest rates should rise modestly in 2018, in our opinion. Unless inflation jumps sharply and significantly above 2%, we expect the Federal Reserve to remain patient and cautious, raising rates slowly throughout 2018.
That means long-term interest rates are also likely to rise slowly. And continuing stimulus policies by foreign central banks are keeping foreign long-term rates below those in the U.S. After a double-digit increase in stocks over the past year, you may need to reduce stocks and add fixed income to return to the appropriate mix of stocks and bonds for you. We think one of the most important ways you can prepare for 2018 is to rebalance your portfolio by adding investment-grade fixed income if needed.
3. What could trigger higher volatility? Possible reasons for stock market pullbacks include rising interest rates, elevated political uncertainty, a shift in sentiment or unexpected changes in fiscal, monetary or trade policies. Historically, a correction, which is when stocks drop by 10% or more, occurs about once a year. Fortunately, it’s been almost two years since the last correction, but we think wise investors should prepare for a return to normal volatility in 2018.
To prepare, add investment-grade bonds and cash to your portfolio as needed to help reduce its volatility. In the past, bond prices rose when stocks dropped, helping stabilize portfolio values. And you may want to keep a little extra cash on hand so you can add stocks at lower prices during pullbacks if appropriate. Most important, though, is to prepare emotionally, since staying invested when markets drop requires patience and discipline.
We think it’s realistic to expect further gains in global stocks and modest interest rate increases, along with more volatility. But also expect lower returns over time.
Over the past five years, the S&P 500 has returned an average of more than 15% per year, twice as much as we expect long-term. As a result, valuations are above average. In the past, above-average stock market valuations were followed by below-average long-term returns. Over the next 10 years, we think U.S. stock returns will be below our long-term range of 6% to 8%. However, we expect international stock returns to be higher than U.S. returns, helping improve the outlook for well-diversified portfolios.
In 2017, investors could view the world through rose-colored glasses, created by double-digit stock market returns and calm markets. We think you need to remove those glasses for a more realistic view of 2018 and beyond. Staying patient, disciplined and invested will be critical.
Past performance of the markets is not a guarantee of how they will perform in the future.
Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates, and investors can lose some or all of their principal.
Small- and mid-cap stocks tend to be more volatile than large-cap stocks.
Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.
This information is for educational and illustrative purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation.