In his “Guide to the Markets” presentation at the 2017
PLANADVISER National Conference, David Kelly, Ph.D., CFA, and managing
director, chief global market strategist and head of J.P. Morgan Funds’ global
market insights strategy team, likened the U.S. economy to a “healthy tortoise”
that will produce 2% annual gross domestic product (GDP) growth but, over the
near term, will be unable to reach 4% or even 3%.
“[After] a 37-year bull run in fixed income, yields are now very low,” Kelly said, forecasting that the slow GDP growth will inevitably lead to a 2% return in fixed income over the next five years. Despite projections that stock earnings will be strong in the third quarter of this year, investors “will be lucky to earn 5% in equities in 2018. Valuations—a Shiller’s 30.1 price/earnings [P/E] ratio—are looking high, in the ninth year of a bull market. This is the third-longest stock market expansion since the Civil War,” he said, adding that, when the market inevitably contracts, “this will create a problem for long-term investors.”
However, drilling down on international equity earnings and
valuations, Kelly said, “You need to look overseas. Emerging markets and Europe
both have room to grow and will do better over the next five years, potentially
delivering 10% returns a year. I don’t think the world economy has looked this
good in a long, long time, so global central banks don’t need to keep helping
it. In fact, they will begin to subtract assets. The U.S. Federal Reserve is now
finally trying to normalize its balance sheet. The Fed’s securities are
maturing, which will cause it to reduce its balance sheet by $450 billion a
year, which will boost interest rates.”
Kelly noted that the Fed has announced it will raise the federal funds rate one more time this year, and he believes it will do so another three times in 2018 and 2019 each. “The market hasn’t priced this in yet because the cash market has been depressed by the actions of central banks,” he said.
NEXT: Stocks with promise
Examining returns and valuations by sector for U.S. stocks also yields promise, Kelly continued. Year to date through June 30, technology stocks delivered 17.2%, consumer discretionary stocks 11.0%, industrials 9.5%, materials 9.2%, financials 6.9% and real estate 6.3%, he said. “Creating a portfolio that includes U.S. stocks that are overweight and underweight will help you.”
Nonetheless, in the near term, Kelly believes that the infrastructure rebuild that will occur following the devastating Hurricanes Harvey, Irma and Nate could result in GDP growth of 2.5% to 3.5% in the third quarter. However, because of the long-term suppression in GDP growth, there is a 5% chance for recession in the fourth quarter, a 20% chance in 2018, a 40% chance in 2019 and a 50% chance in 2020.
Kelly gave a number of reasons for why GDP growth is being stifled, including a Congressional Budget Office (CBO) forecast of a federal budget deficit of -3.6% of GDP in 2017, growing to a deficit of -5.2% by 2027.
And, despite the argument by the current U.S. administration that an increase in GDP will pay for a corporate and personal tax cut, “with U.S. unemployment at a 48-year low of 4.2%, and 2 percentage points below a 50-year average of 6.2%, we are at full employment. Data released at 8:30 this morning by the Bureau of Labor Statistics showed that there are 1.89 million people in the U.S. filing for unemployment—the lowest since 1973. We are scraping the sediment of the labor market barrel. Unless we change immigration laws, GDP growth will slide down to 1.5% to 2.0% a year,” he said.
Regardless, retirement plan advisers need “to remind people of the importance of being invested in the long run, which will inevitably result in the difference whether they can retire to ‘Mudville’ or Malibou,” Kelly said, reminding advisers that “diversification is critical. Over the past 15 years, a diversified portfolio has delivered average returns of 7.5% a year. This year, it will be 11.5%. Going forward, it may do less well” but is still important. Between 2002 and 2016, cash has delivered average returns of 0.8%, “so it still makes sense to invest in something.”