How good are you at reading moods? the answer could be the key to a healthy portfolio over the next couple of years. Consider the following quote from the late Sir John Templeton, a renowned investor with an eye for stock market value: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” The most important tasks for investors in 2018 will be to figure out where we are on that timeline and position their portfolios accordingly.
It’s clear that the animal spirits so lacking in this bull market’s long climb are returning to Wall Street. And it’s no wonder stocks in the U.S. have been on a tear. Major economies across the globe are on a synchronized growth track, corporate earnings growth both here and abroad is robust, and business executives and consumers are confident. Standard & Poor’s 500-stock index has returned 21% since we published our 2018 outlook, eclipsing even the most bullish scenario in our forecast. That broad market benchmark notched a record high 60 times over the period, leaving stock prices elevated compared with long-term averages by almost every measure. (All prices and returns in this article are as of October 31.)
Make no mistake: This bull market is closer to the end of its journey than to the beginning. If it survives beyond August, it will be the longest-running bull ever. But we are optimistic (not yet euphoric) that this bull has some room left to run. “The market will continue to grind higher,” says David Lafferty, chief market strategist at Natixis Asset Management, “but the risks are fairly high.”
Mindful that the broad market has not suffered a meaningful downturn since the 14% decline that ended in early 2016, we think a total return of 8% or so, including roughly two percentage points from dividends, seems reasonable for 2018. Our conservative forecast would put the S&P 500 at about 2730 and the Dow Jones industrial average somewhere in the neighborhood of 24,800 at year’s end. Passage of comprehensive tax reform could push markets higher. And the chance of a runaway rally is increasing, says strategist Ed Yardeni, of Yardeni Research—although, he quips, “an earnings-led melt-up isn’t a melt-up, it’s a bull market.”
It behooves investors to look back at how far they’ve come and make some portfolio adjustments. Several years’ worth of spectacular gains may have tilted your portfolio too much toward stocks considering your age, risk tolerance or stage in life. Now is a good time to rebalance your holdings. And although the bond market will face challenges in 2019, don’t forget that Treasury and other high-quality bonds serve as ballast in a portfolio, providing diversification, buffering volatility and, usually, moving in the opposite direction of stocks during market downturns. Finally, investors who have a global mindset will fare better than those with a parochial view—some of the best returns will likely be found outside the U.S.
