1. US GDP growth
Real US GDP grew by 3.1 per cent annualised in the second quarter and 3.2 per cent in the third. It may slow to a roughly 2.5 per cent pace in the fourth, on a slump in inventory growth before picking up again in early 2018, led by strong consumer and investment spending, partly reflecting tax cut impacts. However, later on this year it should begin to taper off again due to a lack of pent-up demand among consumers and a real difficulty in finding workers, which could limit both consumer and investment spending.
2. US unemployment
Friday’s jobs report could show the US unemployment rate falling to a fresh 17-year low of 4.0 per cent. If they achieve 3 per cent real GDP growth during 2018, then even assuming some increase in labour force participation and strong productivity growth, the unemployment rate could fall to 3.4 per cent by the end of the year – the lowest number seen since 1969.
3. Wages
The single biggest economic puzzle of this expansion has been the failure of wages to rise faster, with Friday’s employment report likely to still show less than 2.5 per cent year-over-year growth in production and non-supervisory worker average hourly earnings. However, even recognising the forces that may be suppressing wages, some acceleration is likely in 2018, with year-over-year wage gains possibly heading to 3.0 per cent by the end of the year.
4. Federal Reserve
Despite significant personnel turnover, the Fed in 2018 will probably stay on the path it laid out in statements last year. In particular, barring some economic shock, it will stick with its plan to reduce its balance sheet. However, when, in December, FOMC members projected three rate hikes in 2018, they also projected 2.5 per cent year-over-year GDP growth and 3.9 per cent unemployment by the fourth quarter. If growth is stronger and unemployment is lower, we could see four rate hikes instead.
5. Long-term interest rates
Over the course of 2017, while the federal funds rate rose 0.75 per cent, 10-year treasury yields fell by 0.05 per cent, ending the year at 2.40 per cent. Like the wage puzzle, it is remarkable how low long-term yields have stayed despite a clearly improving global economy and Fed tightening. However, in 2018, the forces boosting long-term rates should strengthen including further rate hikes from the Fed, a less accommodative stance among other central banks, some increase in US inflation, stronger economic growth and a rising US budget deficit. With all this occurring, it seems unlikely that long-term treasury yields could remain immune, so there is a good chance that the 10-year yield will reach 3.00 per cent by the end of the year.
6. Credit spreads
One other feature of the bond market in 2018 was a continuing tightening in credit spreads, with mortgage rates, Baa corporate bond yields and high-yield corporate bond yields falling by between 0.3 per cent and 0.5 per cent, despite only a fractional decline in 10-year treasury yields. A strong economy and low default rates should generally keep spreads tight in 2018, as should a need among investors to rebalance recent equity market gains. However, as Fed tightening continues and growth prospects weaken heading into 2019, further spread compression is unlikely. In short, last year’s Fed tightening didn’t increase the cost of borrowing for consumers or businesses. In 2018, it probably will.
7. Earnings
There is widespread optimism about corporate earnings in 2018. According to Standard and Poor’s, analysts expect S&P 500 operating earnings per share to come in at just under $125 for 2017, up 18 per cent over 2016, and then rise a further 16 per cent to over $145 for 2018. Some of this reflects stronger oil prices and a lower dollar. However, these estimates are also likely pencilling some of the positive impact of tax reform. One problem is that corporate tax law changes will severely muddy the accounting, making it difficult to see either the net effect of tax reform or the offsetting impacts of strong growth but higher wages and interest rates on corporate income. A key to understanding equities in 2018 will not just be forecasting earnings but interpreting them.
8. Global manufacturing PMI
Some of the best indicators we have on the state of the global economy are monthly manufacturing PMI numbers. Early numbers for December suggest the aggregate global manufacturing PMI index may have hit a fresh six-and-a-half year high at the end of last year. This will be important to watch all year long, in part because of its impact on US growth, but more importantly because of what it signals in terms of opportunities in global equities for US investors.
9. The dollar
In 2017, despite solid US economic growth and Fed tightening, the dollar fell by roughly 10 per cent. In 2018, despite faster growth and more aggressive Fed tightening, it could fall some more. The key question is whether investors can look past a 2018 pick-up in growth, recognising that it is temporary and instead focus on a significant trade deficit, slower long-term US growth prospects and a US administration that is less enamoured of strong dollar than any of its recent predecessors. If the dollar does fall further, it could boost global commodity prices and US inflation and steel the Federal Reserve’s resolve in normalising US monetary policy.
10. Life expectancy at 65
Finally, 2018 may be a year to think optimistically about your health. A December report from the CDC showed that life expectancy at birth fell for the second consecutive year in 2016 to 78.6 years. This is clearly a troubling trend, reflecting in part an increase in deaths from drug overdoses. However, the same report showed life expectancy at age 65 staying at an all-time high of 18 years for men and rising to a new all-time high of 20.6 years for women. On average, a woman celebrating her 65th birthday can also expect to celebrate her 85th. Moreover, this is just the average. Good genes, good personal health habits and access to good health care services can obviously boost these numbers.