It would be great to see a repeat of 2017 in the new year. And we may start off that way as the impact of U.S. tax reform starts to affect corporate bottom lines in the first quarter.
Consumer spending should also benefit. Some companies have already announced pay raises and bonuses. AT&T will pay $1,000 (U.S.) bonuses to more than 200,000 people while Comcast is doing the same for 100,000 of its staff. Wells Fargo is raising its minimum wage. Netflix is increasing the compensation packages of senior executives. Boeing says it will spend $300-million on "employee-related and charitable investments."
On top of that, economists are predicting that the tax cuts will lead to significant dividend increases and share buybacks as companies pass on the benefits to shareholders.
Of course, all this is being paid for by higher deficit financing, which will come home to haunt the United States at some point. But in the meantime, the fallout from the tax cuts should fuel U.S. stock markets for at least the first quarter of 2018. We should expect to see more record highs during that period.
But once that initial euphoria wears off, then what? Wall Street came through 2017 without a major correction. That doesn't happen very often. To expect a recurrence this year would be tantamount to thumbing our noses at history. So here is my first prediction for 2018.
U.S. stocks will move higher initially, followed by a correction of 10 per cent+
I know I sound like a broken record on this one. I called for a correction last year and it never happened. But the market doesn't go up forever; sooner or later it corrects and consolidates before beginning a new upward trend. I believe that will happen this year. It's even possible we could see the start of a new bear-market cycle, although that could be forestalled if Donald Trump is able to push through more business-friendly initiatives, such as the launch of a major infrastructure plan, and U.S. economic growth continues.
Action: Review your portfolio and take some profit on stocks that are likely to be hardest hit by a correction. These would include high-flying tech issues and materials.
Here are some other things to watch for this year.
Higher interest rates
Rates are going to move higher. It's not a matter of if; only when and how often. The U.S. economy continues to gain momentum and the President's pro-business initiatives should maintain that pace in 2018. It now appears the U.S. Federal Reserve Board will raise its key rate at least three times in 2018; perhaps more if the economy continues to accelerate. The Bank of Canada may be slower to move because of worries about the North American free-trade agreement, but at least two increases are likely.
Borrowers will be negatively affected, but savers are unlikely to benefit much. The banks have become notoriously slow at passing on higher rates to GIC investors or raising the rates on their savings accounts. You'll still find the best returns at smaller institutions that are scrambling for market share.
Action: If possible, lock in current rates on your loans. If you are a GIC investor, use a laddered approach. That will ensure you will have money maturing each year to reinvest as rates inch higher.
Return of inflation
We've been living with low inflation for so long that most people have forgotten the time in the early 1980s when the Bank of Canada was struggling to keep sky rocketing prices from escalating into hyperinflation. We're nowhere near that stage now, but the November CPI number of 2.1 per cent annualized was up 50 per cent from the October figure of 1.4 per cent. In the United States, November inflation was 2.2 per cent. An aberration? Perhaps. But with the Canadian economy outpacing expectations and the United States on a roll, higher prices down the road look inevitable.
Action: Start building inflation calculations into your investment decisions. A Royal Bank five-year GIC paying 1.6 per cent will actually end up losing money for you with inflation at 2.1 per cent.
Bond market woes
Rising interest rates will continue to put pressure on bonds. We haven't moved into a bear market yet, although that can happen if rates increase too quickly.
Action: High-yield bonds are risky, but they offer the best returns in the current market conditions. The DEX High Yield Bond Index had gained 9.88 per cent for 2017 as of the close of trading on Dec. 27.
Trade wars deepen
Mr. Trump has not abandoned his promise to pull the United States out of what he views as one-sided trade deals. One of his first acts on taking office was to abandon the Trans-Pacific Partnership. He then launched a renegotiation of NAFTA that is showing every sign of failure. He is escalating his attacks on China and is suspending trade talks with the European Community. This President is an isolationist unlike any we have seen since Herbert Hoover. He seems to relish the idea of wiping out all his country's traditional trading partnerships in the hope of persuading more companies to invest in production facilities in the United States.
Action: Mr. Trump's anti-trade agenda is likely to escalate in 2018. Unless there is an unexpected change in U.S. policy, NAFTA will be dead by year-end and Canada will be scrambling to forge a new trading relationship with an indifferent Washington. Companies that depend heavily on U.S. exports for profitability should be avoided.
The loonie will fall
Our currency did very well in 2017, posting its biggest gain against the U.S. dollar since 2009. If oil prices keep rising (West Texas intermediate crude moved to more than $60 on Friday), it could continue to remain strong in 2018. However, U.S. production levels are expected to rise and since the United States is effectively our only market, that could end up reducing demand for our production and put downward pressure on Canadian oil prices.
A lot will come down to interest rates. If the Federal Reserve Board takes a more aggressive approach than the Bank of Canada, as many expect, it is hard to see how our dollar can hold its ground against the greenback this year.
Action: If you need U.S. currency, convert now.
Let me close by reminding you we live in an unpredictable world. Events will occur in 2018 that we have no way of anticipating today and they could turn every investing strategy upside down.
So stay on top of the news and be prepared to act at a moment's notice.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.
Gordon Pape