Over the past eight years, extraordinarily accommodative monetary policy has served as the primary catalyst for spurring continued economic growth in the U.S. and around the globe. Although the economic expansion has delivered steady gross domestic product (GDP) growth, consistent returns for the broad stock market, and an improving job market, the expansion itself has been lackluster. While we’re still set in a familiar scene, solidly in this economic expansion, we need some new characters to take charge—to bring the market back to its traditional roots and raise the bar on what we expect from global growth, a continued expansion, and one of the longest and largest bull markets in history.1

At LPL Research, we’re looking ahead to a “return of the business cycle.” Instead of relying on intervention by the Federal Reserve (Fed) to propel employment and personal consumption, we will turn to fiscal policy and improving business fundamentals to spur further growth in the economy and stock market. Regarding fiscal policy, we’ll look for increased government spending and tax cuts, which could provide added support for businesses in terms of revenue, earnings, and future growth prospects.

We often talk about cycles in terms of the economic periods of recession and expansion. And while we’re not returning to the beginning of that economic cycle, what we’re referring to here is a return to the traditional drivers that propel the cycle. We are looking to the forces that have historically supported economic and market growth, before we entered this recent period of accomodative monetary policy. The economic cycle still matters and we put ourselves solidly in the second half, although with a potentially low likelihood of a recession starting in 2018. But what may be more important in the next year is the fundamental shift we’ve experienced in what’s driving the cycle and what it means for businesses and investment returns.

In short, we expect to return to an environment in which investors may be rewarded for their ability to focus on business fundamentals, as markets respond to the shift from monetary to fiscal support and greater incentives for entrepreneurial risk-taking. The LPL Research Outlook 2018: Return of the Business Cycle reminds investors of where we have been, what we have accomplished, and why the return of these market forces may bring new opportunities for market participants. With this guidance and investment insight, investors will be ready to embrace this market environment in their search for long-term success.

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IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. All performance referenced is historical and is no guarantee of future results. Estimates may not develop as predicted.

All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy.

Economic forecasts set forth may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential illiquidity of the investment in a falling market.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise and bonds are subject to availability and change in price.

Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk.

Long/short equity funds are subject to normal alternative investment risks, including potentially higher fees; while there is additional management risk, as the manager is attempting to accurately anticipate the likely movement of both their long and short holdings. There is also the risk of “beta-mismatch,” in which long positions could lose more than short positions during falling markets.

Event driven strategies, such as merger arbitrage, consist of buying shares of the target company in a proposed merger and fully or partially hedging the exposure to the acquirer by shorting the stock of the acquiring company or other means. This strategy involves significant risk as events may not occur as planned and disruptions to a planned merger may result in significant loss to a hedged position.

DEFINITIONS

Quantitative easing (QE) is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

Credit ratings are published rankings based on detailed financial analyses by a credit bureau specifically as it relates the bond issue’s ability to meet debt obligations. The highest rating is AAA, and the lowest is D. Securities with credit ratings of BBB and above are considered investment grade.

Small cap is a term used to classify companies with a relatively small market capitalization. The definition of small cap can vary, but it is generally a company with a market capitalization of between $300 million and $2 billion. The prices of small cap stocks are generally more volatile large cap stocks.

A mid cap company is a company with a market capitalization between $2 billion and $10 billion. The prices of mid cap stocks are generally more volatile than large cap stocks.

Large cap refers to a company with a market capitalization value of more than $10 billion.

Yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The most frequently reported yield curve compares the 3-month, 2-year, 5-year, and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.

Option-adjusted spreads (OAS) represent the difference between the index yield and the yield of a comparable maturity Treasury. The OAS can be used to measure the risk levels markets are placing on high-yield bonds. As spreads widen, investors demand a higher yield relative to lower-risk Treasuries, meaning risk levels have increased.

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

INDEX DEFINITIONS

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

Russell 1000® ValueIndex measures the performance of those Russell 1000 companies considered undervalued relative to comparable companies.

The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, governmentrelated and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS (agency and non agency).

The Bloomberg Barclays U.S. Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes U.S. dollar-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers.

Bloomberg Barclays U.S. Corporate High Yield Bond Index measures the U.S. dollar-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

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