The stock market started off the year in full swing with a 5.57% year-to-date return on the S&P 500 Index and a 10-year Treasury bond yield at 2.72% as of market close January 30, 2018. The economy grew at an annualized real GDP growth rate of 2.60% in Q4 2017 according to the Bureau of Economic Analysis (BEA). The inflation rate based on the Consumer Price Index (CPI) is currently at 2.10% and increasing according to the Bureau of Labor Statistics (BLS). The unemployment rate is currently 4.10% and continuing to decline (BLS). Wages grew at 2.90% according to the Federal Reserve Bank of Atlanta's Wage Growth Tracker but is still below the long-term average of 3.60%. The Conference Board Index of Leading Economic Indicators increased in December 2017 making it the 19th consecutive month without a decline in the Index. Finally, the output gap (difference between the value of GDP estimated as if the economy were on its trend growth path and the actual value of GDP) has finally closed for the first time since 2007 according to the The Wall Street Journal.
I believe these economic statistics herald a transition from the early upswing to the late upswing phase in the business cycle. The output gap has closed and the economy may be showing early signs of overheating. Confidence is high and unemployment is low. The economy may grow rapidly as inflation starts to pick up, with wages accelerating as shortages of labor develop. The Federal Reserve is increasingly becoming more restrictive in their monetary policy by raising benchmark interest rates which increases borrowing costs. Still, a boom mentality takes hold during this phase as investors still on the sidelines jump into the markets for fear of missing out.
I expect the economy to continue on its trend growth path and even surpass it in 2018. I expect the stock market to continue its uptrend as the economy enters the late upswing phase of the business cycle. However, I also would not be surprised by a 10.00% market correction which I would consider normal and healthy. I expect wage growth to continue catching up to the long-term average growth rate of 3.60%. I expect inflation rates to continue rising above 2.00% prompting the Federal Reserve to raise the federal funds rate three times in 2018 as indicated by the Federal Open Market Committee's Summary of Economic Projections. I expect rates on mortgages and auto loans to increase by approximately 0.75%, in line with three rate hikes. I expect the first 0.25% rate hike for the year to be on March 21, 2018 with a 94.50% chance according to Bloomberg. To summarize, our outlook for 2018 is highly positive and I am optimistic going forward. Risks to our assessment would include a significant unexpected deterioration of the economic fundamentals highlighted above which I believe is highly unlikely. Additionally, unforeseen shocks could occur like a war or natural disaster. Always consult with your financial adviser about your asset allocation and any concerns you may have regarding these risks.