The last week ended with the Dow 30 and S&P 500 having slight losses and the Nasdaq ending pretty much unchanged after a market selloff in the last 15 minutes of Friday.   Many things can affect the markets at month end and year end such as tax loss and gain harvesting and option expirations.  Therefore, we believe the late Friday selloff is not likely indicative of a trend going into next year.  For the holiday shortened week, the 10 year Treasury note yield declined as did the dollar.  West Texas Intermediate Crude oil closed above $60 for the first time since 2015 due to strong demand and declining inventories.

We ended 2017 with good gains in U.S. Stocks and even better gains internationally as a synchronized global expansion has taken place.  Lower valuations overseas, especially in Europe, have helped attract investments outside the U.S.  A weakening dollar in 2017 has also boosted the value of foreign investments in U.S. dollar terms.  As we look forward to 2018 we will begin to see the effects of tax changes.  The repatriation of foreign earnings and lower tax rates should boost dividends and share buybacks which could help support or boost U.S. stock prices if that hasn’t been baked in already.

Companies will invest some of the tax savings in capital and hiring, but only to the extent that they see continuing demand for their products and good investment opportunities.  Unlike the Field of Dreams movie line, “if you build it, they will come”, companies want to know that there will be demand for any expansions so they are good stewards for their shareholders.  Expansions will happen if companies decide to bring more production here from overseas and perhaps to export more, but that will take months or years.  The personal tax cuts may boost demand domestically, however that demand is already good.  Frankly, I believe the time for such fiscal stimulus should have been in 2010 to prime the pump.  Stimulus coming this late in the economic cycle, will have diminishing returns.

Looking forward to 2018 we see the following risks and reward potentials:

• Improved corporate earnings and reduced corporate debt due to the new tax law should support or boost stock prices.
• The dollar could strengthen due to the repatriation of $500BN or more in corporate earnings held overseas as well as the FED rate increases and accelerated unwinding their balance sheet.
  • This may negatively affect overseas investments in U.S. dollar terms.
  • This may also negatively affect trade imbalances by making foreign goods cheaper than U.S. goods in dollar terms.
• The FED, which stopped quantitative easing in 2014 still bought bonds to replace those that mature.  In October 2017, the FED started letting $10BN of bonds “fall off” their balance sheet each month.  In other words $10BN per month of money is being electronically destroyed.  This is scheduled to increase by $10BN every quarter reaching a maximum of $50BN a month in the 4^th quarter of 2018.  The FED also has predicted three more quarter percent increases of short term rates in 2018.
  • We expect to see both short term and long term rate increases in 2018.
  • We believe the FED’s unwinding of its balance sheet is a good strategy to keep the yield curve from inverting.  An inverted yield curve is one in which short term rates are higher than long term rates which usually spells trouble for the economy.
  • Rising interest rates should boost the dollar.  However, the effect of the resulting rate increases on the dollar also depend on where rates go overseas.  Europe has begun tapering its quantitative easing and may be done after September.  Japan has also quietly scaled back its asset purchases.
• We believe a shooting war with North Korea has a small risk of happening, but if it did, it could be devastating in terms of human life and investments.
• While unfair trade practices need to be addressed we see a risk from protectionist actions which could actually harm the U.S. economy.
• Expect more political stalemates in Washington.  There are midterm elections this year and that is not conducive to compromise.  The Republican majority is now only one seat in the Senate.
  • While both Republicans and Democrats are saying they want increased infrastructure spending, they are far apart on how to do it.
    • Democrats want the federal government to spend $1TN more on infrastructure while Republicans are envisioning spending $200BN to create public/private partnerships, an unproven strategy.
    • After massive tax cuts, such spending may be even harder to achieve.  Neither side seems willing to do something sensible like raising the gas tax to pay for it.
  • We still don’t have a budget passed for the fiscal year that started in October.  The latest continuing resolution takes us to January 19.
    • A compromise will likely need to address DACA, or Deferred Action for Childhood Arrivals which must be addressed by March.
    • The possibility exists of a shutdown if an agreement is not reached by January 19^th.  This likely will not happen but will there could be yet another continuing resolution.
• Inflation which has remained below the FED’s and many foreign central banks target of 2%, baffling many economists, could ignite causing more aggressive rate hikes.
  • If the OPEC and non-OPEC production cuts through the end of 2018 cause a sustained rise in oil prices, this will eventually boost overall inflation.
  • Protectionist moves such as large increases in tariffs could boost inflation by boosting prices of goods that are no longer made in the U.S.
• Now that tax reform has passed we may see a pause in the markets until 4^th quarter earnings start coming out in mid-January.  Forecasts call for a double digit increase in 4^th quarter earnings.  Also, if we get a fiscal budget passed before January 19^th that should help.

Having cited the potential risks, our belief is that economic expansion most likely will continue through 2018 and market prices of stocks will likely end 2018 higher.  We believe that volatility will increase.  We have seen extremely low volatility in the past 18 months.  That likely will not continue for long.  Both short and long interest rates will likely rise through 2018 but unless inflation rises above the FEDs 2% target it likely will not become more aggressive in raising rates.

In the numbers, this week:

• The S&P CoreLogic Case-Shiller National Home Price Index rose 6.2% in the 12 months ended in October up from the 6.1% 12 month increase at the end of September.
  • The Labor Department reported  first time claims for unemployment were unchanged at 245,000.  The four week moving average of claims rose 1,750 to 237,750.
• The Energy Information Administration’s Weekly Petroleum Data report is here wpsrsummary (16).  In addition, the EIA reported:
  • Weekly field production of crude oil fell 35,000 barrels per day in the prior week.
  • Natural gas in storage fell 112BNcf last week from the prior week.
• Baker Hughes reported that oil drilling rigs fell 2 to 745.  Gas drilling rigs fell 2 to 182.

Please call us if you have any questions.

Best Regards,

Loren C. Rex, CFP^®, AIF^®, MA                                                              Erik Smith

President                                                                                                      Managing Partner

Generations Financial Planning & Wealth Management                   269-441-4143

77 E. Michigan Ave, Suite 140

Battle Creek, MI  49017

Tel:  269-441-4090

Carrie Fuce, Assistant 269-441-4091

Toll Free: 800-513-8180

Fax:  866-381-2301

Visit our Website:  www.genfinplan.com

Registered Representative of and securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC.  Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor.  Cambridge and Generations Financial Planning & Wealth Management are separate companies and are not affiliated.

These are the opinions of Loren Rex and Erik Smith and are not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice.