Turnaround Investing Blog

George Putnam, one of the country's leading turnaround and distressed investing professionals, shares his timely insight on the economy and turnaround investing opportunities.

2018 Stock Market Outlook: More Gains Likely But With A Bumpier Ride

Excerpted from the January 2018 Issue

Simply put, stock markets across the globe were strong in 2017. As of this writing, the S&P 500 has produced a 22% return year-to-date. In Europe, the MSCI Europe index has gained a respectable 11%, while the MSCI Pacific index returned 17%. Nearly every developed country market produced positive returns. Emerging market stocks surged 26%, their strongest gain since 2009, led by the 50% return in China. 

Despite expert forecasts to the contrary, the anticipated “low-return environment” never happened. The S&P 500 has produced an annualized return of more than 15% over the past five years and more than 8% from the highs just prior to the 2008 financial meltdown. 

Technology stocks drove the S&P 500 this year. The largest index component, Apple, returned about 51%. Three other tech stocks (Microsoft, Facebook and Alphabet), with a combined index weight of 28%, gained an average of 43%. The telecommunications sector was the worst performing sector in the index with a -5.6% return, followed by energy, -4.0%. 

Reversing last year’s results, growth stocks overwhelmed value stocks, propelled by technology shares. The Russell 1000 Growth index gained 31% compared to the 13% return for the Russell 1000 Value index. Small cap stocks, as measured by the Russell 2000 index, gained a respectable but still lagging 14.6%.

Bond returns were positive but lackluster. The Barclay’s Aggregate, which includes a wide range of government and corporate bonds, returned 3%, while the B of A Merrill Lynch High Yield bond index returned 7%.

With the year almost in the history books, how did we do with our 2017 forecast? We were spot-on with our view that the economy would strengthen and that deflation would shift toward inflation. Our lack of enthusiasm for bonds in general was correct, as was our view that high yield bonds would be better-rewarded. However, while directionally right, we hugely underestimated the stock market’s rise, as well as the strength in mega-cap tech stocks that drove growth and large cap ahead of value and small cap. 

As baseball legend Yogi Berra once said, “It’s tough to make predictions, especially about the future.” With all the humility that any outlook requires, we can make an easy case for more stock market gains in 2018, as nearly every indicator points in this direction. Low interest rates, strengthening economies and more stimulus from the United States’ landmark tax law should foster more earnings growth and provide an overall supportive environment. 

But as contrarians, we see this view as being widely held and at risk of becoming the “only” view. With valuations high and signs of excessive speculation starting to appear, we are well-aware of how quickly any change in the increasingly one-sided sentiment can produce impressive levels of volatility. And, as volatility is widely used to measure risk, investors may then pull back further to reduce risk and leverage. The catalyst could be any of the widely discussed geopolitical or monetary issues or some other unidentified problem.

With that, we see a 6% increase in stocks for the S&P 500 in the coming year, but with a bumpier ride than the ruler-straight gains of 2017. Value and large cap should outperform growth and small cap in 2018. We expect mediocre returns from bonds, but slightly better returns from high yield. This type of market favors an emphasis on stocks with low expectations and real value--in other words, turnaround stocks.

The January issue of The Turnaround Letter also shared detailed analysis of our top-five value stock opportunities for 2018. Subscribe now for immediate access to more of George Putnam’s latest market advice and turnaround stock picks.

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Turnaround Letter Stock Pick Named Top Performer of 2017

 

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What Last Year's Top Stock Pickers Are Buying in 2018

 

This Forbes write-up follows up on the recent Top Stock Tips report--naming The Turnaround Letter's Crocs recommendation the top performer of 2017: With 90% gains, CROX beat out 100 other investment ideas included in the report; and the stock continues to have value investing appeal, according to Putnam.

 

George notes, "We see additional upside for the stock in 2018 as management's efforts continue to bear fruit, though the gains will likely be more muted than we saw in 2017."