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FED

Investor focus will be on the Fed's economic forecasts and expected # of rate hikes in 2018, less so 2019. Mkt is pricing in roughly 2 hikes next year vs 3 that the Fed has in its dot plots.

The tax cut package will likely complicate the Fed’s job in the next year and so how the Fed talks about that in terms of the growth/inflation outlook will also be important. Fiscal stimulus in a late stage economy near full employment is likely to risk higher inflation which could push the Fed into a policy mistake - raising rates too far, too fast, creating a self inflicted inverted yield curve which both stock and bond investors are likely to take as a sign of impending recession.

The yield curve (2/10yr UST spread) had flattened  considerably over the past year with short rates up close to 70 bps while 10 year rates have rallied roughly 10 bps leading to a yield curve of under 60bps which is very flat on a historical basis.With the long end supported by a demand imbalance between supply and demand for long duration, safe assets the Fed may be hamstrung in its efforts to raise ST rates.

It would be ironic if the tax cuts meant to boost growth actually do the opposite by creating the groundwork for an inverted yield curve which leads to stocks and bonds selling off creating potential recessionary conditions. Things are further complicated by what will essentially be a new Fed Board with Chair, Vice Chair and NY Fed Pres all turning over in the coming 6 months.

Higher short term rates may also support the USD which could reverse the USD weakening trend seen this year, a trend which boosted US corporate earnings thus providing support to US equity.

GROWTH/EQUITY MARKET

US and perhaps more importantly global growth is expected to be strong for the next several years - the OECD analyses 45 countries and it expects an average global growth rate of roughly 3.6% for 2017-2019 with none of those countries in recession over that three year period.

Such growth has led to quite strong earnings growth which has been the principal support for equity prices in 2017. Fun Fact: global equities, up roughly 20% this year, are trading on a cheaper PE multiple today than a year ago - you never see that stat cited in all the “bubble” talk.

So on the plus side for stocks in 2018: one of the most synchcronized global economic recoveries of the past thirty years leading to solid earnings growth. US stocks may be supported by a one off earnings boost driven by the tax cut leading to perhaps 15% EPS growth in 2018 - its hard to see big stock mkt downside with that EPS growth.

On the downside four main tailwinds are morphing into headwinds: stock buybacks are ebbing, dollar weakness turning to stability/strength, Central Bank liquidity is starting to reverse and China credit fueled growth is turning into tough love deleveraging. 

Bottom line: investors should raise their volatility expectations and lower their return assumptions. Expect another year of non US equity outperformance - Japan and Europe most attractive. In US focus on small caps, industrials, financial, energy and telecoms.